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![administrator can only move from one objective to another if s/he thinks that
it is not reasonably practicable to achieve a preceding objective. The adminis-
trator, however, is obliged to move from (a) to (b) if s/he thinks that (b) would
achieve a better result for the company’s creditors as a whole.5
The underlying principle behind restructuring or reorganisation proceed-
ings is that a business may be worth a lot more if preserved, or even sold, as a
going concern than if the parts are sold off piecemeal.6 In other words, there
is a surplus of going-concern value over liquidation value.7 In the UK, the DTI
review of company rescue and business reconstruction mechanisms8 has
spoken of:
a growing sense that, in many cases, rescue or reconstruction, whether informal or
moderated through formal insolvency procedures, probably benefits everyone
involved with a company and its business more than a liquidation. The basis of this
belief is that the ‘fire sales’ of assets that accompany such terminal procedures as
liquidation inevitably reduce the values obtained whereas creditors will, over time,
receive a better return where the company survives as a ‘going concern’.
In the US, as one court put it, ‘the purpose of [Chapter 11] is to provide a
debtor with the legal protection necessary to give it the opportunity to reorga-
nize, and thereby to provide creditors with going-concern value rather than the
possibility of a more meagre satisfaction of outstanding debts through liqui-
dation [under Chapter 7 of the Bankruptcy Code].’9 Influential US commen-
tators have reduced the liquidation versus reorganisation question to a
quasi-mathematical formula. It has been suggested that whether a company
should be kept together as a going-concern is answered by estimating the
4 Corporate rescue law – an Anglo-American perspective
5 Ibid para 3(4).
6 For a somewhat sceptical perspective see Douglas G Baird and Robert K
Rasmussen ‘The End of Bankruptcy’ (2002) 55 Stan L Rev 751 at 758: ‘We have a
going-concern surplus (the thing the law of corporate reorganizations exists to
preserve) only to the extent that there are assets that are worth more if located within
an existing firm. If all the assets can be used as well elsewhere, the firm has no value
as a going-concern.’ Richard V Butler and Scott M Gilpatric see ‘going-concern
surplus’ more broadly in ‘A Re-Examination of the Purposes and Goals of Bankruptcy’
(1994) 2 American Bankruptcy Institute Law Review 269 at 282 – ‘part of the going-
concern surplus represents the value to the firm of the relationships which it has estab-
lished with factor owners. The rest reflects the value to it of its relationships with
customers, regulators, and other interested parties.’
7 Omer Tene ‘Revisiting the Creditors’ Bargain: The Entitlement to the Going-
Concern Surplus in Corporate Bankruptcy Reorganisations’ (2003) 19 Bankruptcy
Developments Journal 287.
8 London, DTI, 2000 at p 5.
9 Canadian Pacific Forest Products Ltd v JD Irving Ltd (1995) 66 F 3d 1436 at
1442.](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-17-2048.jpg)
![income stream that the assets would generate if they were kept together, taking
into account the risk of reorganisation failure, discounting that stream to
present value, and comparing it to the amount that the assets would realise if
they were sold off in separate pieces.10
Since going-concern value may be a lot more than the value of a business
on a break-up basis, reorganisation proceedings are designed to keep the busi-
ness alive so that this additional value can be captured.11 This objective is
itself controversial for there is a widely held view that if a company encoun-
ters economic difficulties the simplest and most effective solution is to put it
out of its misery, so to speak, by terminating its existence. If a business is no
longer viable then the most sensible solution may be to shut it down.12 If a
company is producing goods and services for which there is no ready market
then why leave it in existence? For example, take the case of a dog food
company that is producing food that the dogs do not like. There seems little
gain in keeping such a company alive.13 Moreover, preserving dying compa-
nies or putting them on a life support and resuscitation machine may do little
to benefit the industry in which they operate. Instead, it may leave competitors
Introduction 5
10 See DG Baird and TH Jackson ‘Corporate Reorganizations and the Treatment
of Diverse Ownership Interests: A comment of adequate protection of secured creditors
in bankruptcy’ (1984) 51 U Chi Law Review 97 at 109. See also Thomas H Jackson
The Logic and Limits of Bankruptcy Law (Cambridge MA, Harvard University Press,
1986) at p 184. For a European perspective see Horst Eidenmueller ‘Trading in Times
of Crisis: Formal Insolvency Proceedings, Workouts and the Incentives for
Shareholders/Managers’ [2006] European Business Organization Law Review 239 at
241–242.
11 But see Charles W Adams ‘An Economic Justification for Corporate
Reorganizations’ (1991) 20 Hofstra L Rev 117 at 133 ‘[M]ost assets are probably not
firm-specific, and so, most insolvent corporations will not have substantially greater
going concern than liquidation values and, consequently, will not be good candidates
for an effective reorganization.’
12 For a different view of Chapter 11 see Lynn M LoPucki ‘The Debtor in Full
Control – Systems Failure Under Chapter 11 of the Bankruptcy Code?’ (1983) 57
American Bankruptcy Law Journal 99 at 114: ‘Congress has asserted that “the purpose
of a reorganization . . . case is to formulate and have confirmed a plan of reorganiza-
tion . . .” It is likely that only a few of the debtors studied came to Chapter 11 for this
purpose. A large majority of them entered Chapter 11 with one or more of their credi-
tors in hot pursuit, and filing was probably the only way they could remain in business
or avoid liquidation. Their focus, quite naturally, was on short term survival, and only
later, if at all, would a substantial number of them turn their attention to the long range
prospects for their businesses.’
13 See generally Michelle J White ‘Does Chapter 11 Save Economically
Inefficient Firms’ (1994) 72 Wash U LQ 1319; ‘The Corporate Bankruptcy Decision’
(1989) 3 J Econ Persp 129; James J White ‘Death and Resurrection of Secured Credit’
(2004) 12 American Bankruptcy Institute Law Review 139.](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-18-2048.jpg)
![These points have been well made by the Legal Department of the
International Monetary Fund (IMF), who go so far as suggesting that changes
in the nature of the economy have meant that restructuring of ailing firms has
become more important than ever before:
[I]n the modern economy, the degree to which an enterprise’s value can be maxi-
mized through liquidation of its assets has been significantly reduced. In circum-
stances where the value of a company is increasingly based on technical know-how
and goodwill rather than on its physical assets, preservation of the enterprise’s
human resources and business relations may be critical for creditors wishing to
maximize the value of their claims.
Simply stated, some companies are worth more as going-concerns run by
existing managers and with existing shareholders than if sold to third parties
and managed by new teams.21 The going-concern surplus may result from the
informational advantages of existing management or from the sunk costs of
arranging assets in strategic blocks. The surplus has to be substantial, however,
to justify the very substantial administrative, negotiating and legal costs of the
reorganisation proceedings themselves.22
In the US context, on the other hand, the world of Chapter 11 has changed
such that there is now a much greater emphasis on market sales rather than
reorganisations in the traditional sense.23 But, contrary to the position that
might have appeared during the fall-out from the bursting of the bubble in
technology-related shares in 2001/2002, traditional reorganisations have not
completely disappeared. There is empirical evidence that reorganisation
remains essential for dealing with distressed large public companies.24
Commentators have compared the prices for which 30 large public companies
were sold with the values of 30 similar companies that were reorganised in the
2000/2004 period. It was found that companies sold for a 35 per cent average
of book value but reorganised for an average fresh value of 80 per cent of book
value. Moreover, the average market capitalisation value as determined by
post-reorganisation market trading was 91 per cent of book value. ‘Even
controlling for the differences in the prefiling earnings of the two sets of
companies, sale yielded only half of reorganization value. These results
8 Corporate rescue law – an Anglo-American perspective
21 See D Baird and R Picker ‘A Simple Noncooperative Bargaining Model of
Corporate Reorganizations’ (1991) 20 J Legal Studies 311 at 315.
22 Robert Clark ‘The Interdisciplinary Study of Legal Evolution’ (1981) 90 Yale
Law Journal 1238 at 1254.
23 See Douglas G Baird ‘The New Face of Chapter 11’ (2004) 12 American
Bankruptcy Institute Law Review 69 at 71.
24 Lynn M LoPucki and Joseph W Doherty ‘Bankruptcy Fire Sales’ (2007) 106
Michigan Law Review 1 at pp 3–4.](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-21-2048.jpg)
![While the distinction between economic distress and financial distress may
be a useful analytical tool, it may also be a bit blunt at times. The two concepts
seem to shade into one another. Although financially distressed businesses are
not necessarily in economic distress, a business model that is not working can
easily generate liquidity problems and the failure to meet debt-servicing oblig-
ations.27
FORMAL AND INFORMAL RESCUE
As is made clear throughout this book the emphasis in practice in the UK is on
business rescue rather than corporate rescue. Corporate rescue may be
achieved through administration coupled with a CVA but this is the outcome
in only a small minority of administrations.28 Chapter 11s are more likely to
result in a confirmed plan of reorganisation.29
At least in the British context, there is the widespread view that the value
of a company is best preserved through informal restructuring or reorganisa-
tion procedures.30 The commencement of formal proceedings may cause a
10 Corporate rescue law – an Anglo-American perspective
27 See generally on the distinction and its usefulness Gregor Andrade and Steven
N Kaplan ‘How Costly is Financial (No Economic) Distress? Evidence from Highly
Leveraged Transactions that Became Distressed’ (1998) 53 Journal of Finance 1443
and also Douglas G Baird ‘Bankruptcy’s Uncontested Axioms’ (1998) 108 Yale LJ 573
at 580–583.
28 See the empirical study ‘Report on Insolvency Outcomes’ – a paper presented
to the Insolvency Service by Dr Sandra Frisby which is available on the Insolvency
Service website – www.insolvency.gov.uk. This reports (at p 63) a ‘general view that
the only genuine rescue mechanism is the CVA within the protection of administration.
Of those rescue outcomes recorded on the database all but two involved CVAs within
administration, which would appear to support that view.’
29 See generally Chapter 3 and in particular Professor Lynn LoPucki’s bank-
ruptcy research database – http://lopucki.law.ucla.edu. Professor LoPucki’s book
Courting Failure: How Competition for Big Cases is Corrupting the Bankruptcy
Courts (Ann Arbor, University of Michigan Press, 2005) in Chapter 4 ‘Failure’contains
an extensive account of Chapter 11 plan confirmation rates and refilling rates – see, for
example, the tables on pp 100, 101, 113 and 120. Professor Theodore Eisenberg in
‘Business Insolvency Law: Creating an Effective Swedish Reconstruction Law’
(Stockholm, Centre for Business Policy Studies, Occasional Paper No 75, 1995)
reports that US Chapter 11 plan confirmation rates decrease with company size: the rate
is 96 per cent for companies with assets greater than $100m, 36 per cent for companies
with assets between $1m and $100m and 20 per cent for firms with less than $1m in
assets.
30 See A Tilley ‘European Restructuring: Clarifying Trans-Atlantic
Misconceptions’ [2005] Journal of Private Equity 99 at 102: ‘European restructuring is](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-23-2048.jpg)
![loss of customer confidence and the disruption of business operations. The
importance of achieving the survival of the company without recourse to
formal procedures has also been linked to broader social and governmental
trends about auditing performance more actively and adopting proactive risk
management strategies. Corporate actors are encouraged to see corporate
decline as a matter to be anticipated and prevented rather than responded to
after the event.31
PRIVATE WORKOUTS IN THE US
Out-of-court workouts are common on both sides of the Atlantic, though the
ease by which debtors can make use of Chapter 11, and the advantages that
Chapter 11 brings, have probably reduced their importance in the US.32 But
even in the US it has been suggested that there are often clear advantages in
preserving enterprise value by the parties seeking a consensus before a
formal Chapter 11 filing. It is perhaps only in situations that are too complex
for the stakeholders to reach a negotiated consensus or where the rejection
of, what the Americans term, ‘onerous legacy costs’ is crucial that the formal
process is used. These are the practicalities that drive the selection of the
appropriate process in a particular case.33 Empirical study suggests that
Introduction 11
still best achieved out of administration, and with the exception of the U.K. among the
major economies, is still inflexible, bureaucratic, and value destructive. For this reason
international practitioners favour the U.K. as a jurisdiction should a choice be avail-
able.’ See also on the US/European contrast C Pochet ‘Institutional Complementarities
within Corporate Governance Systems: A Comparative Study of Bankruptcy Rules’
(2002) 6 Journal of Management and Governance 343; M Brouwer ‘Reorganization in
US and European Bankruptcy Law’ (2006) 22 European Journal of Law and
Economics 5, and see generally Alice Belcher Corporate Rescue (London, Sweet &
Maxwell, 1997) at pp 116–142.
31 See V Finch ‘The Recasting of Insolvency Law’ (2005) 68 MLR 713, and see
also V Finch ‘Doctoring in the Shadows of Insolvency’ [2005] JBL 690.
32 See S Gilson ‘Managing Default: Some Evidence on How Firms Choose
between Workouts and Chapter 11’ in J Bhandari and L Weiss eds Corporate
Bankruptcy: Economic and Legal Perspectives (Cambridge, Cambridge University
Press, 1996) p 308.
33 For an argument that the distinction between in-court, and out-of-court,
restructuring has become meaningless from a governance perspective see Ethan S
Bernstein ‘All’s Fair in Love, War & Bankruptcy? Corporate Governance Implications
of CEO Turnover in Financial Distress’ (2006) 11 Stanford Journal of Law, Business
and Finance 298. This paper suggests that in 2001 filing for bankruptcy did not change
the role of CEO turnover when one controls for financial condition. The shadow of
bankruptcy has lengthened making bankruptcy law a central tenet of governance policy
regardless of whether a Chapter 11 petition is ever filed.](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-24-2048.jpg)
![capital structure of the company is comparatively straightforward. An increase
in the number of creditors adds to the likelihood that any one creditor will hold
out and thus make disputes among creditors more likely. Complex capital
structures also generate difficulties in terms of putting a value on claims and
disagreements amongst creditors over whether they are being treated fairly,
relative to other creditors or shareholders.
In certain circumstances, recourse to Chapter 11 may have certain advan-
tages over private workouts. For instance, a successful workout is dependent
on a high level of creditor consensus. If a high proportion of creditors agree to
a restructuring plan then there may be enough spare cash or leverage to buy
out the dissenters, but if the hold-outs are too great then this option ceases to
be a practical possibility. If too many creditors engage in holdouts then the
whole project is endangered by this strategic behaviour.42 The Chapter 11
super-majority voting and cramdown rules can overcome holdouts.43 Chapter
11 also contains a stay on creditor enforcement actions which stops a creditor
from calling in its debt or enforcing security while restructuring negotiations
are in progress.44 The provisions in Chapter 11 for super-priority new finance
may also alleviate some funding problems that an ailing company may face.45
Moreover, Chapter 11 contains a mechanism for the rejection of collective
bargaining agreements already negotiated by the company and for cuts to be
made to retiree health care benefits.46 In other words, a company can shed
some of its employment costs in Chapter 11. In American jargon these are
onerous legacy costs for rustbelt industries. Wage levels and health benefits
must be forced downwards to cope with foreign competition and changes in
the nature of the economy. These issues are addressed in more detail in
Chapter 7. There is nothing directly equivalent in UK administration, but as
one commentator remarks:47 ‘New pensions legislation could be seen to be
encouraging a move into UK administration to deflect under-funding liabili-
ties to a proposed Government-legislated but industry-funded contingency
fund. Legacy issues are not just a preserve of US airlines, it seems.’
14 Corporate rescue law – an Anglo-American perspective
42 See Horst Eidenmueller ‘Trading in Times of Crisis: Formal Insolvency
Proceedings, Workouts and the Incentives for Shareholders/Managers’ (2006) 7
European Business Organization Law Review 239 at 254–255 who suggests the impo-
sition of cooperation duties on creditors.
43 S 1129 of the Bankruptcy Code.
44 S 362.
45 S 364.
46 Ss 1113 and 1114.
47 See A Tilley ‘European Restructuring: Clarifying Trans-Atlantic
Misconceptions’ [2005] Journal of Private Equity 99 at 102.](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-27-2048.jpg)
![highlighted the existence of an elaborate rescue process outside formal proce-
dures.51 According to this study:
About 75% of firms emerge from rescue and avoid formal insolvency procedures
altogether (after 7.5 months, on average). Either they are turned-around or they
repay their debt by finding alternative banking sources. . . . Turnarounds are often
accompanied by management changes, asset sales, and new finance or directors’
guarantees. There is evidence that these changes significantly influence the bank’s
response and the likelihood of a successful outcome.
Leading lenders may be able to use their leverage to force distressed compa-
nies to restructure, whether by means of downsizing, management replace-
ment or otherwise. Moreover, the willingness of the company to restructure
is significantly related to the size of debt repayments demanded by the bank.
During the restructuring period however, the evidence also indicates that the
exposure of the bank is substantially reduced whereas the debts due to trade
and other creditors tend to expand. Trade creditors bear the major part of the
risk associated with the restructuring process as they do not share the bank’s
knowledge of the company’s financial position and their lending is unse-
cured.
In the 1980s, the Bank of England developed a set of principles – the
‘London Approach’ – for multi-lender corporate workouts and these guide-
lines became public by means of publications from Bank officials. The Bank
of England’s interest in corporate workouts stemmed from its core responsi-
bilities relating to the maintenance of financial stability and the promotion of
an effective and efficient financial system.52 The ‘London Approach’ involved
a willingness by the main creditors to consider a non-statutory resolution of a
company’s financial difficulties, the commissioning of an independent review
of the company’s long-term viability and the operation of an informal morato-
16 Corporate rescue law – an Anglo-American perspective
51 See J Franks and O Sussman ‘The Cycle of Corporate Distress, Rescue and
Dissolution: A Study of Small and Medium Size UK Companies’ (2000). This study
was sponsored by the DTI/Treasury Working Group on Company Rescue and Business
Reconstruction Mechanisms. See also Cook, Pandit and Milman ‘Formal
Rehabilitation Procedures and Insolvent Firms: Empirical Evidence on the British
Company Voluntary Arrangement Procedure’ (2001) 17 Small Business Economics.
See also the policy document ‘Banks and Businesses Working Together’ from the
British Bankers Association website – www.bba.org/.
52 On the ‘London Approach’ see generally P Brierley and G Vlieghe ‘Corporate
Workouts, the London Approach and Financial Stability’ [1999] Financial Stability
Review 168; P Kent ‘Corporate Workouts – A UK Perspective’ (1997) 6 International
Insolvency Review 165; J Flood, R Abbey, E Skordaki and P Aber The Professional
Restructuring of Corporate Rescue: Company Voluntary Arrangements and the London
Approach (1995) ACCA Research Report No 45.](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-29-2048.jpg)
![rium on creditor enforcement procedures during the review period. The main
creditors try to arrive at a joint view about whether, and on what terms, the
company is worth supporting on a long-term basis and a coordinating, or lead,
bank may be designated to facilitate these discussions. Generally, the lead
bank will be the bank with the largest exposure to the company and it is
usually also the bank with whom the company has its main banking relation-
ship.
Creditors form a steering committee and this constitutes a forum to which
some decisions by lenders can be delegated. During the review period, the
existing credit facilities are maintained in place by the lenders and, in addition,
they may provide supplemental lending if there is a need for further liquidity
support. This new finance may come from one or more of the existing lenders
and normally assumes priority over existing exposures. If the company is
deemed to be viable on a long-term basis by the financial review and there is
support for this among creditors, then the creditors will consider longer-term
arrangements such as extending loan repayment periods, providing additional
financial support or converting debt into equity. Creditors may also be asked
to consider a so-called ‘haircut’, i.e. an element of debt forgiveness. As a
condition of gaining the cooperation and support of its creditors, the company
will usually have to implement an agreed business plan and this may entail
management changes, the sale of assets or divisions, or even the acceptance of
a takeover bid.
The role of the Bank of England may have diminished in multi-creditor
corporate workouts, if indeed it ever played a significant role at all apart from
acting as a general ‘honest broker’. The rise of hedge funds, debt trading and
the general fragmentation of the financial markets has caused perceptions of
the Bank’s role to alter but nevertheless, all market participants are acquainted
with the fact that a company with its business operations intact is much more
valuable than a company whose customers have fled elsewhere on the
commencement of formal proceedings.53
In the US there has been nothing equivalent to the semi-official status of the
London Approach for multi-lender debtor workouts but a shared set of expec-
tations among lenders towards debtor default undoubtedly exists based on a
community of interests.
Introduction 17
53 See generally J Armour and S Deakin ‘Norms in Private Bankruptcy: the
“London Approach” to the Resolution of Financial Distress’ [2001] Journal of
Corporate Law Studies 21.](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-30-2048.jpg)
![The procedural school also suggests that the secured creditor’s property
rights should not be sacrificed for the benefit of the unsecured creditors, and
where secured creditors are prevented from enforcing their collateral during
rescue proceedings without being provided with full compensation, the effect
‘is not merely wrong, it is outrageous’.86
On the other hand, critics may think that it is over-simplistic to suggest that
insolvency law is, or should be, merely about protecting pre-insolvency enti-
tlements. Certain issues come to the fore during the insolvency process and it
is only right that these should be addressed during that process. Directorial
misconduct is one such issue and, under s 7(4) Company Directors
Disqualification Act, the administrator is obliged to report to the DTI Director
Disqualification Unit whether the director’s conduct in relation to the
company in administration renders him unfit to be concerned in company
management in the future. One could devise a system under which a director’s
conduct could be examined at any point during the company’s history with a
view to ascertaining whether disqualification was an appropriate response.
Implementation of such a system would necessitate a massive bureaucracy
however, and confining the disqualification option to situations where a
company enters a formal insolvency process seems a defensible pragmatic
response.87
Professor Goode makes the point that certain problems confronting
claimants outside the common pool creditors arise specifically because of the
company’s insolvency and for no other reason. ‘[T]o treat bankruptcy law as
confined to creditors confronting the common pool problem is surely to
prejudge the very question in issue. It is also wholly inconsistent with insol-
vency laws around the world, all of which include provisions for claimants
outside the common pool creditors.’88
26 Corporate rescue law – an Anglo-American perspective
86 Ibid at 641. The point is also made by Jackson Logic and Limits of Bankruptcy
Law at 189.
87 For a less extreme proceduralist theory of bankruptcy law see E Brunstad and
M Sigal ‘Comparative Choice Theory and the Broader Implications of the Supreme
Court’s Analysis in Bank of America v 203 North LaSalle Street Partnership’ (1999) 54
Business Lawyer 1475 text accompanying 234 ‘Bankruptcy law does not exist in a
vacuum, nor does it operate in one. Rather, it operates against a backdrop of pre-exist-
ing legal structures. These structures are important because . . . they govern commer-
cial relations generally, and care must be taken to avoid bankruptcy rules that alter
commercial expectations in ways that generate more harm than good. This does not
mean . . . that bankruptcy law should never modify commercial procedures. In many
instances, modifications are necessary to promote the goals of the Chapter 11 regime.
But it does not follow that all non-bankruptcy norms are, therefore, irrelevant, or
should be ignored simply because a firm files for bankruptcy relief.’
88 See Goode Principles of Corporate Insolvency Law at p 45. But see Jackson
Logic and Limits of Bankruptcy Law at p 26: ‘Bankruptcy law cannot both give new](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-39-2048.jpg)
![suggested that there is a prohibition on even purely prospective restrictions on
secured creditors. Otherwise, one would be making the assumption that the
property rights held by secured creditors are in some sense anterior to positive
law, and that is an extreme proposition.94
MORE INCLUSIVE ‘BARGAIN’ MODELS
There are, of course, bargain theories of insolvency law suggesting that regard
should be had to non-creditor interests. For instance, Professor Korobkin has
propounded a normative framework for insolvency law based on a hypotheti-
cal bargain as devised by the representatives of all interests that might by
affected by a debtor’s financial distress. On this model, the bargainers all
know they may be affected by the insolvency, but no one knows if s/he will be
a debtor, an unsecured creditor whether contractual or involuntary, a secured
creditor, an ordinary employee, a member of the community that is otherwise
unconnected to the debtor company or somebody in a different kind of rela-
tionship. Korobkin suggests that this inclusive hypothetical group would seek
to protect those who are rendered most vulnerable by the insolvency and come
up with something approximating to the major features of current US bank-
ruptcy law.95
With more specific relevance to the UK, this inclusive hypothetical
bargaining model has been developed by Dr Rizwaan Mokal into an ‘authen-
tic consent model (ACM)’ which aims to analyse and justify the principles of
insolvency law.96 The authentic consent model also extends participation in
28 Corporate rescue law – an Anglo-American perspective
94 The European Convention on Human Rights (incorporated in domestic
English law through the Human Rights Act 1998) provides in Article 1 of the First
Protocol: ‘Every natural or legal person is entitled to the peaceful enjoyment of his
possessions. No one shall be deprived of his possessions except in the public interest
and subject to the conditions provided for by law and by the general principles of inter-
national law.’ Article 1 adds however, that the preceding prescriptions do not in any
way impair the right of a State to enforce such laws as it deems necessary to control
the use of property in accordance with the general interest or to secure the payment of
taxes or other contributions or penalties. Article 1 was considered by the House of
Lords in Wilson v First Country Trust Ltd (No 2) [2004] 1 AC 816 in the context of the
Consumer Credit Act 1974; on which see generally J De Lacy ‘Company Charge
Avoidance and Human Rights’ [2004] JBL 448.
95 For the exposition of Professor Korobkin’s theory see ‘Rehabilitating Values:
A Jurisprudence of Bankruptcy’ (1991) 91 Columbia Law Review 717;
‘Contractarianism and the Normative Foundations of Bankruptcy Law’ (1993) 71
Texas Law Review 541; ‘The Role of Normative Theory in Bankruptcy Debates’
(1996) 82 Iowa Law Review 75.
96 See RJ Mokal ‘The Authentic Consent Model: Contractarianism, Creditors’](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-41-2048.jpg)
![that if the reorganisation procedure is to serve only the interests of creditor-
owners, why should a board of directors elected by the shareholders remain in
control of the company?109 In the UK, by contrast, administration operates as
a management displacement device with the administrator assuming the
management tasks formerly entrusted to the board of directors.110
The two systems differ also with regard to reorganisation plans. In the US,
a class of creditors, including secured creditors, can be forced by the court to
accept a reorganisation plan through a mechanism known as ‘cram down’,
even though creditors are theoretically protected by the so-called absolute
priority rule and by the ‘best interests of creditors’ test.111 The absolute prior-
ity rule means that the reorganisation plan must follow the scheme of
priorities established by the law. The ‘best interests of creditors’ test applies in
favour of each individual creditor and shareholder and requires that they
should receive at least as much under the reorganisation plan as they would
receive in a liquidation of the company under Chapter 7 of the US Bankruptcy
Code.112 While liquidation values do establish a floor, a reorganisation plan
has considerable latitude with regard to the distribution of the going-concern
surplus.113 In the UK, on the other hand, there is less flexibility about propos-
32 Corporate rescue law – an Anglo-American perspective
109 See LoPucki ‘A Team Production Theory of Bankruptcy Reorganization’ at
768.
110 On the relative merit of debtor-in-possession versus management displace-
ment insolvency regimes see D Hahn ‘Concentrated Ownership and Control of
Corporate Reorganisations’ (2004) 4 JCLS 117. See also V Finch ‘Control and co-ordi-
nation in corporate rescue’ [2005] Legal Studies 374; O Brupbacher ‘Functional
Analysis of Corporate Rescue Procedures: A Proposal from an Anglo-Swiss
Perspective’ (2005) 5 JCLS 105.
111 On cram down see Jack Friedman ‘What Courts do to Secured Creditors in
Chapter 11 Cram Down’ (1993) 14 Cardozo Law Review 1496 who suggests at 1499
that ‘the traditional mystique concerning cram down which instills fear among secured
creditors is exaggerated. Cram down is applied in a remarkably homogenous and
predictable manner regarding secured claims.’
112 See generally s1129 of the US Bankruptcy Code.
113 See the views expressed in the US Congress about entitlements to the
‘surplus’ value produced by a liquidation case – ‘The parties are left to their own to
negotiate a fair settlement. The question of whether creditors are entitled to the going-
concern or liquidation value of the business is impossible to answer . . . Instead, nego-
tiation among the parties after full disclosure will govern how the value of the
reorganizing company will be distributed among creditors and stockholders. The bill
only sets the outer limits on the outcome: it must be somewhere between the going-
concern value and the liquidation value’ – HR Rep No 595, 95th Cong, 1st Sess 224
(1977). For a slightly different perspective see Omer Tene ‘Revisiting the Creditors’
Bargain: The Entitlement to the Going-Concern Surplus in Corporate Bankruptcy
Reoganizations’ (2003) 19 Bankruptcy Developments Journal 287 at 326 ‘Chapter 11
is a forum for structured bargaining among classes of investors. Bankruptcy law should](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-45-2048.jpg)
![The multiple values or eclectic approach towards evaluating insolvency
law has in turn been criticised for vagueness, uncertainty and indeterminacy.
The multiple values approach may be unable to provide concrete standards for
judging concrete cases or proposals. For example, little assistance is offered to
decision-makers on the management of tensions and contradictions between
different values or on the way that trade-offs between various ends should be
carried through. In addition, there are no core principles to determine trade-off
or to establish weightings.123
A variant on the multiple values approach is to set out, explicitly, various
values or benchmarks for evaluating insolvency and corporate rescue law. This
approach is favoured by Professor Finch who suggests that the legitimacy of
the processes and principles of insolvency law can be tested by reference to
four benchmarks, namely: efficiency, expertise, accountability and fairness.124
There has been criticism of this benchmarking approach however, largely
because of a perceived failure to distinguish between substantive and proce-
dural goals.125 Substantive goals are those which justify the existence of this
part of the law by showing it in its best light while procedural goals, on the
other hand, are about how the law goes about attaining its substantive goals.
Simply stated, a distinction should be drawn between the ultimate ends of the
law, and the methods that the law adopts in attempting to achieve those ends:
‘Once a set of substantive goals has been exogenously specified (e.g. using a
theory of justice) [procedural goals] can be used to judge between various
proposed schemes for implementing it.’
Applying this analysis, the benchmarks of efficiency, expertise and
accountability are largely about means and not ends. Consequently, ‘fairness’
is left standing as the sole substantive goal and bears a heavy burden of analy-
sis and explanation.126 On the other hand, if one adds ‘justice’ to the mix and
then proceeds to examine corporate rescue law from the perspective of justice
as well as fairness, this may not lead us any closer in the direction of provid-
ing specific proposals or solutions for specific situations.127 Perhaps, the best
Introduction 35
123 See Vanessa Finch ‘The Measures of Insolvency Law’ (1997) 17 OJLS 227 at
241.
124 See generally V Finch, ibid; Vanessa Finch Corporate Insolvency Law:
Perspectives and Principles (Cambridge, Cambridge University Press, 2002).
125 See the review article by RJ Mokal ‘On Fairness and Efficiency’ (2003) 66
MLR 452 and see also RJ Mokal Corporate Insolvency Law: Theory and Application
(Oxford, Oxford University Press, 2005) at p 67 fn 31.
126 Vanessa Finch in ‘The Measures of Insolvency Law’ (1997) 17 OJLS 227 at
252 acknowledges that trade-offs ‘between different rationales do remain a problem
but . . . the absence of easy answers has to be accepted when dealing with processes
whose essence is the balancing of multiple objectives.’
127 RJ Mokal in Corporate Insolvency Law: Theory and Application develops an](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-48-2048.jpg)
![more secured or preferential creditors.130 An administrator can only descend
this statutory hierarchy of objectives if s/he thinks that it is not reasonably
practicable to achieve any of the preceding objectives even though an admin-
istrator has to move from (a) to (b) if he thinks that (b) would achieve a better
result for the company’s creditors as a whole. While the administrator cannot
act solely in the interests of a creditor who may have initiated the administra-
tion process, producing better returns for company creditors appears, at the
end of the day, to be essentially what administration is about.131
The first objective stated in the legislation (though not necessarily the
primary objective) is rescuing the company as a going-concern. The parlia-
mentary debates make it clear that this objective is about preservation of the
business of the company rather than preservation of the company as an empty
corporate shell.132 The government stressed: ‘We would not want the admin-
istrator to rescue the company if it is to the detriment of creditor value.’133
In many cases an administrator may reach a rapid conclusion that a sale of
assets achieves a better result for company creditors than preserving the busi-
ness of the company as a going concern. There seems little scope for chal-
lenging an administrator’s judgement on this matter although it is provided in
Schedule B1 para 74 Insolvency Act that a creditor or member may complain
to the court that the administrator is acting, or has acted, so as unfairly to harm
the interests of the applicant and/or others, or is proposing to act in such a
manner. Moreover, the administrator has a duty, in the statement setting out
proposals for achieving the purpose of administration, to explain why the
‘rescue’ objective cannot be achieved, and this statement may provide some
ammunition to form the basis of a court challenge.134 The relevant test though,
is what the administrator ‘thinks’ and not what s/he ‘reasonably believes’.
Introduction 37
130 Insolvency Act 1986 Schedule B1 para 3(1). An administrator must also
perform his/her functions in the interests of the company’s creditors as a whole – para
3(4)(b).
131 See S Frisby ‘In Search of a Rescue Regime: The Enterprise Act 2002’ (2004)
67 MLR 247 at 262 and more tentatively Vanessa Finch ‘Control and Co-ordination in
Corporate Rescue’ [2005] Legal Studies 374 at 395–396: ‘The terms of EA 2002 mean
that it is arguable that an administrator is obliged to pursue a going-concern sale where
he thinks this will serve creditors better than efforts made to rescue the company – even
where it might be possible to rescue the company. Primacy is accordingly given to
maximising overall returns to creditors, rather than to rescue per se.’ See also D
Prentice ‘Bargaining in the Shadow of the Enterprise Act 2002’ (2004) 5 European
Business Organization Law Review 153 at 158.
132 See the comments by Lord Hunt of Wirral in the House of Lords – HL debates
col 765, 29 July 2002.
133 See the comments by the relevant Minister, Lord McIntosh of Haringey, in HL
Debates col 766, 29 July 2002.
134 Schedule B1 para 49(2)(b).](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-50-2048.jpg)
![While the state of a person’s mind may be as much a fact as the state of the
person’s digestive tract, the ‘thinks’ test leaves little scope for judicial
review.135 It is not generally the practice of the courts to second-guess the
commercial judgements of administrators and other discretionary decision-
makers. It was explained during the parliamentary debates:136
The administrator is the person on the ground who is best placed to judge whether
or not a particular objective is reasonably practicable, in the light of his experience
and professional judgment. . . .[I]t will be for the administrator to reach a conclu-
sion as to whether or not the objectives are reasonably practicable, taking into
account all the circumstances of the particular case of which he or she is aware at
the time.
The emphasis placed in the legislation on the administrator’s opinion may
make judicial intervention virtually impossible provided that the opinion has
been formed in good faith.137 One commentator suggests138
the likely practical effect of the paramount regard to what is in the best interest of
the company’s creditors as a whole is that there will be a few instances where the
administrator performs his functions with the objective of rescuing the company as
a going concern. After all, the interests of creditors are more often than not to be
paid as much as possible, and as quickly as possible. Those primarily interested in
a rescue are likely to be employees, guarantors of any debts of the company and
shareholders, interests to which the administrator is not expressly required to have
regard.
The overarching general requirement that an administrator should not
unnecessarily harm the interests of company creditors as a whole139 may go
some of the way towards allowing limited second-guessing of administrators’
decisions in certain contexts. An example is where a company has two assets;
one of which is essential to the carrying on of a company’s business but the
other is not essential. The administrator then decides to sell the key asset,
perhaps because it is a bit more easily saleable, so as to make distributions to
secured and preferential creditors even though the sale has a crippling effect
38 Corporate rescue law – an Anglo-American perspective
135 For somewhat different perspectives see J Armour and R Mokal ‘Reforming
the Governance of Corporate Rescue: The Enterprise Act 2002’ [2005] LMCLQ 28; R
Mokal and J Armour ‘The New UK Rescue Procedure – The Administrator’s Duty to
Act Rationally’ (2004) I International Corporate Rescue 136; M Simmons ‘Enterprise
Act and Plain English’ [2004] Insolvency Intelligence 76.
136 Hansard, HL Deb, col 768, 29 July 2002.
137 See Finch ‘Re-Invigorating Corporate Rescue’ [2003] JBL 527 at 546.
138 See Lisa Linklater ‘The Enterprise Act: Fulfilling Great Expectations’ (2003)
24 Company Lawyer 225.
139 Schedule B1 para 3(4).](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-51-2048.jpg)
![on the further viability of the company’s business. In these circumstances, it
would seem that the administrator has acted in a way that has unfairly and
unnecessarily harmed the interests of company members and creditors.
Therefore this action may be challenged under para 74, whereas it seems that
if an administrative receiver had behaved in a similar fashion, this conduct
could not be impeached.140
Underlying the revised administration procedure appears to be the princi-
ple that if there are ‘alternative courses of action, one of which will benefit
creditors only, and another which, with a little delay, will confer benefits on
employees and shareholders without significant detriment to the creditors,
then it is a legitimate function of insolvency law to have regard to those wider
interests’.141 The interests of employees and shareholders, and indeed wider
community interests, may be subordinate to those of creditors, but they have
their place in the overall scheme of things. This policy is reflected in UK law
as it applies to solvent companies. The appointment of an administrator
displaces the board of directors from their management functions but the
directors are responsible for running the company until the administrator takes
their place. The formulation of director’s duties in the Companies Act 2006
provides that a director must act in the way s/he considers, in good faith,
would be most likely to promote the success of the company for the benefit of
its members as a whole.142 In fulfilling the statutory duty it is specifically
stated that a director must have regard to:
Introduction 39
140 An administrative receiver can choose to exercise or not to exercise the power
of sale over a particular asset. According to the Privy Council decision in Downsview
Nominees v First City Corp [1993] AC 295 the only constraint on the administrative
receiver’s choices is the criterion of good faith. In the words of Professor Sir Roy
Goode in Principles of Corporate Insolvency Law at pp 284–285) Downsview suggests
that: ‘The receiver . . . is entitled, if he so chooses, to decide not to continue the
company’s business, and to sell a part of the business which would be better kept. It
would also seem that he can select a particular asset to realise for the benefit of his
debenture holder even though the removal of that asset would damage the company’s
business and there are other assets to which he could resort and on which the business
is less dependent.’
141 See Roy Goode Principles of Corporate Insolvency Law at p 45.
142 The Company Law Reform Steering Group in ‘Modern Company Law for a
Competitive Environment: The Strategic Framework’ (March 1999) at pp 39–46 set
forth two alternatives. One is that of maintaining what they consider to be the existing
directorial duty of following enlightened shareholder interests. The second alternative
is that of creating a ‘pluralist’ duty to all major stakeholders. See generally on what
interests corporate law should serve, Henry Hansmann and Reinier Kraakman ‘The
End of History for Corporate Law’ in Jeffrey Gordon and Mark Roe ed Convergence
and Persistence in Corporate Governance (Cambridge, Cambridge University Press,
2004) p 33.](https://image.slidesharecdn.com/927222-250618211635-492e5188/75/Corporate-Rescue-Law-An-Angloamerican-Perspective-Corporations-Globalisation-And-The-Law-Gerald-Mccormack-52-2048.jpg)
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- 7. CORPORATIONS, GLOBALISATION ANDTHE LAW Series Editor: Janet Dine, Director, Centre for Commercial Law Studies, Queen Mary College, University of London, UK This new and uniquely positioned monograph series aims to draw together high quality research work from established and younger scholars on what is an intriguing and under-researched area of the law. The books will offer insights into a variety of legal issues that concern corporations operating on the global stage, including interaction with WTO, international financial insti- tutions and nation states, in both developing and developed countries. Whilst the underlying foundation of the series will be that of company law, broadly defined, authors are encouraged to take an approach that draws on the work of other social sciences, such as politics, economics and development studies and to offer an international or comparative perspective where appropriate. Specific topics to be considered will include corporate governance, corporate responsibility, taxation and criminal liability, amongst others. The series will undoubtedly offer an important contribution to legal thinking and to the wider globalisation debate. Titles in the series include: Human Rights and Capitalism A Multidisciplinary Perspective on Globalisation Edited by Janet Dine and Andrew Fagan Company Law in the New Europe The EU Acquis, Comparative Methodology and Model Law Janet Dine, Marios Koutsias and Michael Blecher EU Corporate Law and EU Company Tax Law Luca Cerioni Corporate Governance and China’s H-Share Market Alice de Jonge Corporate Rescue Law – An Anglo-American Perspective Gerard McCormack
- 8. Corporate Rescue Law– An Anglo-American Perspective Gerard McCormack Professor of International Business Law, University of Leeds, UK CORPORATIONS, GLOBALISATION AND THE LAW Edward Elgar Cheltenham, UK • Northampton, MA, USA
- 9. © Gerard McCormack2008 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photo- copying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2008932868 ISBN 978 1 84720 274 1 Typeset by Cambrian Typesetters, Camberley, Surrey Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall
- 10. Contents Preface vi Acknowledgements viii 1Introduction 1 2 Corporate restructuring law in the UK 43 3 Fundamental features of the US Chapter 11 78 4 Entry routes and corporate control 118 5 The automatic stay – barring individual creditor enforcement actions 156 6 Financing the debtor 176 7 The role of employees 209 8 The restructuring plan 251 9 Conclusion 288 Index 309 v
- 11. Preface Britain and theUnited States are sometimes spoken of as two countries divided by a common language. One may find some truth to this paradox in the sphere of insolvency and corporate restructuring. Americans talk of corpo- rate bankruptcy whereas in Britain the talk is of corporate insolvency with the language of bankruptcy in the main confined to the insolvency of individuals. Moreover, Americans speak of corporations and in the UK the talk is of companies. But certainly in the corporate rescue sphere the differences are more deep-rooted than mere matters of terminology. The differences are often presented in the form of a generalisation that US law is pro-debtor and UK law is pro-creditor. US law is based on a debtor-in-possession norm whereas in the UK the norm is that of management displacement. In addition there is super- ficially greater secured creditor control of the restructuring process in the UK. But part of my thesis is that the traditional generalisation is, at best, a poten- tially misleading over-simplification. Debtor-in-possession does not necessar- ily mean that the management team that was responsible for the company’s financial misfortunes remain in control of the business. Creditors in the US can exercise decisive influence over the restructuring process through debtor- in-possession financing agreements. The book also offers the conclusion that there is a degree of functional convergence in practice but, at the same time, acknowledges that corporate rescue, as distinct from business rescue, still plays a larger role in the US. The functional convergence has partly come through the UK Enterprise Act 2002 but the book suggests that the main move has been that of US law and practice in a UK direction with greater emphasis on business disposals and speedier cases than on corporate reorganisations, as traditionally understood. This mirrors practice in the UK where the emphasis has always been on the rescue of businesses through disposals of profitable or potentially profitable parts of a company’s operations rather than carrying on business through the vehicle of the existing corporate entity. This outlook has not changed with the Insolvency Service Evaluation Report (January 2008) on the Enterprise Act revealing that the corporate rescue outcome is achieved in very few cases. The emphasis continues to be on maximising recoveries for creditors by means of business and asset sales. US law contains certain features such as a special funding mechanism for companies in financial difficulties that might usefully be transplanted across the Atlantic if corporate rescue is vi
- 12. going to playa larger role in the UK and the hopes of the architects of the Enterprise Act realised. The focus throughout the book has been on providing a critical compara- tive evaluation of US and UK law, incorporating relevant empirical evidence where appropriate. Developments in other jurisdictions and on the interna- tional level have not been neglected however. Part of the interest in this book may lie in providing a possible way forward for other jurisdictions or at least in illuminating the path not to follow. Gerard McCormack Leeds, UK April Fool’s Day, 2008 Preface vii
- 13. Acknowledgements I have incurredmany debts in the course of writing. Amongst others, thanks are due to Tracey Evans Chan, Andrew Griffiths, Andrew Keay, Herbert Lemelman, David Milman, John McMullen, Maisie Ooi, George Triantis and Wee Meng Seng. I would also like to thank the UK’s Arts and Humanities Research Council (AHRC) for facilitating some of the research on which the book is based and the University of Manchester, National University of Singa- pore and University of Leeds for providing a hospitable academic environ- ment. But the biggest debt is owed to my family – por todo. Finally, my mother passed away during the writing process and I would like to dedicate the book to her memory. viii
- 14. 1. Introduction This bookcompares and contrasts corporate rescue (reorganisation) proce- dures in the UK and the US. A dedicated corporate rescue procedure has existed in the UK since the 1980s in the form of administration, or at least administration coupled with a company voluntary arrangement (CVA). In the US, corporate rescue law is much older, with the law now contained in Chapter 11 of the US Bankruptcy Code 1978. In 2002, by means of the Enterprise Act, UK law was moved in the US direction. US law in this area has traditionally been seen as very ‘pro-debtor’ compared with the UK, which is seen as ‘pro-creditor’.1 Part of the theme of the book is that this generalisa- tion is, at best, a potentially misleading over-simplification. The book will ask a number of questions including the following: 1. Firstly, what values and purposes are served by reorganisation proce- dures? Such procedures are generally premised on the assumption that the ‘going-concern’ value of a business is greater than the liquidation value. The question arises, however, whether the concern of the law should simply be about creditor wealth maximisation or whether a busi- ness should be kept alive for other reasons. Related to this is the issue of the destination of the ‘surplus’ value that is captured during the reor- ganisation process. In distributing this ‘surplus’ value, is the law simply interested in respecting pre-insolvency legal entitlements or should a different set of interests enter into the equation during the reorganisation process? 2. Why are the mechanisms for entering the procedures different in the UK and the US and, in particular, why does the secured creditor have such a central role in the procedure in the UK but apparently not in the US? 3. Why do solvency requirements before a company can enter the reor- ganisation process differ in the UK and the US? There is no insolvency 1 1 See the paper by Rafael La Porta, Florencio Lopez-De-Silanes, Andrei Shleifer and Robert W Vishny (1998) ‘Law and Finance’ 106 Journal of Political Economy 1113, where the US is given a score of 1 for creditors’ rights whereas the UK is given the maximum score of 4.
- 15. prerequisite in Chapter11 but a case can be dismissed early if filed in bad faith or without reasonable hope of success. 4. To what extent does the stay on creditor enforcement proceedings differ between the two countries and what are the conditions for getting the stay lifted? In the US, secured creditors may succeed in having the stay lifted unless the debtor has provided them with ‘adequate protection’ against a decline in the value of their property interests but the question arises about how this concept is interpreted in practice. In the UK, there is ostensibly more of a discretionary approach. 5. What are the reasons for allowing the incumbent management to remain in charge of company affairs during Chapter 11 whereas in the UK responsibility is entrusted to an outside insolvency practitioner? The difference has often been ascribed to a difference in entrepreneurial culture between the two countries, with many in Britain associating business failure with personal fault and stigma whereas in the US, busi- ness failure is often seen as one of the vicissitudes of fortune. But how convincing are these attributions? 6. Unlike in England, there is a specific provision in Chapter 11 to deal with financing of companies undergoing reorganisation – ‘DIP’ financ- ing. Super-priority new financing is even permitted if the debtor can show such a loan is a condition of obtaining new financing and existing secured creditors are adequately protected against loss. The opportunity to introduce a similar procedure in the UK has however been rejected and the research will explore the reasons for this. 7. To what extent can a reorganisation plan be made binding on creditors (including secured creditors) against their wishes? In the US every impaired class of creditors must approve the plan though ‘cramdown’, which means confirmation of a plan despite creditor objections is possi- ble. Generally, a secured class may be crammed down if it receives the value of its collateral, plus interest, over time, while an unsecured class may insist that shareholders receive nothing if a plan is to be approved over its objection. Objecting creditors are protected by the ‘best inter- ests’ test under which each objecting creditor must receive at least as much under the plan as it would in liquidation and also by a ‘feasibility test’ which requires that the debtor should be reasonably likely to be able to perform the promises it made in the plan. In the UK there is no facility for ‘cramdown’. I will endeavour to ascertain to what extent ‘cramdown’ is used in the US and ask whether the differences between the two countries in this respect are more subtly nuanced than would initially appear. The first set of questions looks at the justifications for having corporate 2 Corporate rescue law – an Anglo-American perspective
- 16. rescue laws2 andalso at the philosophy behind such laws. Most people might say that corporate rescue is all about maintaining going-concern value, in that the value of a company’s business operations is likely to be far greater than the scrap value of its assets.3 They may be nonplussed, however, if asked to explain why going-concern value is likely to be greater than the liquidation value of assets. This chapter looks in more detail at the concept of going concern value. It then considers whether a company should be kept alive for reasons other than the preservation of going-concern value. In other words, are there wider purposes served by corporate rescue laws? This leads into a discussion of the various academic theories offered up to justify the existence of corporate rescue laws and which are also used to critique such laws. Finally, the discussion returns to the legislative record in both the US and the UK and to a consideration of the factors that influenced both the enactment and content of Chapter 11 and the administration proce- dure in the UK. GOING-CONCERN VALUE In the UK, administration can be contrasted with liquidation. Liquidation of a company involves the cessation of its business, the realisation of its assets, the payment of its debts and liabilities, and the distribution of any remaining assets to the members of the company. At the end of the liquidation process, a company is wound up and ceases to exist. Administration, or administration coupled with a CVA, by contrast, is designed primarily as a rescue procedure aimed at facilitating the survival of the company’s business either in whole or in part. The legislation states that an administrator must perform his/her func- tions with the objective of (a) rescuing the company as a going concern, or (b) achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being in administration), or (c) realising property in order to make a distribution to one or more secured or preferential creditors.4 The statute sets out this hierarchy of objectives. An Introduction 3 2 One may define ‘rescue’ pragmatically as a major intervention necessary to avert corporate failure – see Alice Belcher Corporate Rescue (London, Sweet & Maxwell, 1997) at p 36. See also A Belcher ‘The Economic Implications of Attempting to Rescue Companies’ in H Rajak ed Insolvency Law: Theory and Practice (London, Sweet & Maxwell, 1991) at p 235. 3 ‘The premise of a business reorganisation is that assets that are used for production in the industry for which they were designed are more valuable than those same assets sold for scrap’ – HR Rep No 595, 95th Congress, Ist Sess 220 (1977). 4 Insolvency Act 1986 Schedule B1 para 3(1). An administrator must also perform his/her functions in the interests of the company’s creditors as a whole.
- 17. administrator can onlymove from one objective to another if s/he thinks that it is not reasonably practicable to achieve a preceding objective. The adminis- trator, however, is obliged to move from (a) to (b) if s/he thinks that (b) would achieve a better result for the company’s creditors as a whole.5 The underlying principle behind restructuring or reorganisation proceed- ings is that a business may be worth a lot more if preserved, or even sold, as a going concern than if the parts are sold off piecemeal.6 In other words, there is a surplus of going-concern value over liquidation value.7 In the UK, the DTI review of company rescue and business reconstruction mechanisms8 has spoken of: a growing sense that, in many cases, rescue or reconstruction, whether informal or moderated through formal insolvency procedures, probably benefits everyone involved with a company and its business more than a liquidation. The basis of this belief is that the ‘fire sales’ of assets that accompany such terminal procedures as liquidation inevitably reduce the values obtained whereas creditors will, over time, receive a better return where the company survives as a ‘going concern’. In the US, as one court put it, ‘the purpose of [Chapter 11] is to provide a debtor with the legal protection necessary to give it the opportunity to reorga- nize, and thereby to provide creditors with going-concern value rather than the possibility of a more meagre satisfaction of outstanding debts through liqui- dation [under Chapter 7 of the Bankruptcy Code].’9 Influential US commen- tators have reduced the liquidation versus reorganisation question to a quasi-mathematical formula. It has been suggested that whether a company should be kept together as a going-concern is answered by estimating the 4 Corporate rescue law – an Anglo-American perspective 5 Ibid para 3(4). 6 For a somewhat sceptical perspective see Douglas G Baird and Robert K Rasmussen ‘The End of Bankruptcy’ (2002) 55 Stan L Rev 751 at 758: ‘We have a going-concern surplus (the thing the law of corporate reorganizations exists to preserve) only to the extent that there are assets that are worth more if located within an existing firm. If all the assets can be used as well elsewhere, the firm has no value as a going-concern.’ Richard V Butler and Scott M Gilpatric see ‘going-concern surplus’ more broadly in ‘A Re-Examination of the Purposes and Goals of Bankruptcy’ (1994) 2 American Bankruptcy Institute Law Review 269 at 282 – ‘part of the going- concern surplus represents the value to the firm of the relationships which it has estab- lished with factor owners. The rest reflects the value to it of its relationships with customers, regulators, and other interested parties.’ 7 Omer Tene ‘Revisiting the Creditors’ Bargain: The Entitlement to the Going- Concern Surplus in Corporate Bankruptcy Reorganisations’ (2003) 19 Bankruptcy Developments Journal 287. 8 London, DTI, 2000 at p 5. 9 Canadian Pacific Forest Products Ltd v JD Irving Ltd (1995) 66 F 3d 1436 at 1442.
- 18. income stream thatthe assets would generate if they were kept together, taking into account the risk of reorganisation failure, discounting that stream to present value, and comparing it to the amount that the assets would realise if they were sold off in separate pieces.10 Since going-concern value may be a lot more than the value of a business on a break-up basis, reorganisation proceedings are designed to keep the busi- ness alive so that this additional value can be captured.11 This objective is itself controversial for there is a widely held view that if a company encoun- ters economic difficulties the simplest and most effective solution is to put it out of its misery, so to speak, by terminating its existence. If a business is no longer viable then the most sensible solution may be to shut it down.12 If a company is producing goods and services for which there is no ready market then why leave it in existence? For example, take the case of a dog food company that is producing food that the dogs do not like. There seems little gain in keeping such a company alive.13 Moreover, preserving dying compa- nies or putting them on a life support and resuscitation machine may do little to benefit the industry in which they operate. Instead, it may leave competitors Introduction 5 10 See DG Baird and TH Jackson ‘Corporate Reorganizations and the Treatment of Diverse Ownership Interests: A comment of adequate protection of secured creditors in bankruptcy’ (1984) 51 U Chi Law Review 97 at 109. See also Thomas H Jackson The Logic and Limits of Bankruptcy Law (Cambridge MA, Harvard University Press, 1986) at p 184. For a European perspective see Horst Eidenmueller ‘Trading in Times of Crisis: Formal Insolvency Proceedings, Workouts and the Incentives for Shareholders/Managers’ [2006] European Business Organization Law Review 239 at 241–242. 11 But see Charles W Adams ‘An Economic Justification for Corporate Reorganizations’ (1991) 20 Hofstra L Rev 117 at 133 ‘[M]ost assets are probably not firm-specific, and so, most insolvent corporations will not have substantially greater going concern than liquidation values and, consequently, will not be good candidates for an effective reorganization.’ 12 For a different view of Chapter 11 see Lynn M LoPucki ‘The Debtor in Full Control – Systems Failure Under Chapter 11 of the Bankruptcy Code?’ (1983) 57 American Bankruptcy Law Journal 99 at 114: ‘Congress has asserted that “the purpose of a reorganization . . . case is to formulate and have confirmed a plan of reorganiza- tion . . .” It is likely that only a few of the debtors studied came to Chapter 11 for this purpose. A large majority of them entered Chapter 11 with one or more of their credi- tors in hot pursuit, and filing was probably the only way they could remain in business or avoid liquidation. Their focus, quite naturally, was on short term survival, and only later, if at all, would a substantial number of them turn their attention to the long range prospects for their businesses.’ 13 See generally Michelle J White ‘Does Chapter 11 Save Economically Inefficient Firms’ (1994) 72 Wash U LQ 1319; ‘The Corporate Bankruptcy Decision’ (1989) 3 J Econ Persp 129; James J White ‘Death and Resurrection of Secured Credit’ (2004) 12 American Bankruptcy Institute Law Review 139.
- 19. suffering by forcingthem to compete with debt-reduced and reorganised, but ultimately inefficient, companies in crowded markets. In this regard, American commentators have highlighted the example of Eastern Airlines in the early 1990s where, in a desperate attempt to win back lost customers, Eastern offered a number of discount fares that priced its services below cost. Such a strategy made sense for the insolvent airline because getting passengers back was Eastern’s only hope to emerge from bankruptcy as a viable entity. Unfortunately, these low fares induced other airlines to reduce their fares, thus generating losses at these other airlines as well. The slow death of Eastern thus compounded the losses of both Eastern’s creditors and its competitors.14 After all, one of the principal characteristics of a market economy is that some companies fall by the wayside, and forcing investors to keep their assets locked up in what is, at best, a marginal enterprise may prevent these investors from making more productive use of their assets in a more efficient enterprise. It also may reduce their incentive to invest, rather than consume, those assets in the first place. Moreover, the effect of keeping open a business in a partic- ular town may be to prevent a potentially more profitable business in a differ- ent town from opening.15 GOING-CONCERN VALUE AND THE MODERN SERVICE SECTOR-ORIENTED ECONOMY It has been suggested that, with changes in the nature of advanced economies and the disappearance of heavy industry, corporate restructurings may have less of a role to play than previously, if any role at all.16 This thesis has been advanced in the American context by Professors Baird and Rasmussen, who argue that because of economic changes and, in particular, technological advances, globalisation and the rise of the service sector, corporate reorgani- sations as traditionally understood are coming to an end.17 In their view: ‘To 6 Corporate rescue law – an Anglo-American perspective 14 See Robert K Rasmussen ‘The Efficiency of Chapter 11’ (1991) 8 Bankruptcy Developments Journal 319 at 320–321. 15 See Baird and Jackson (1984) 51 U Chi L Rev 97 at 102. 16 DG Baird and RK Rasmussen ‘Chapter 11 at Twilight’ (2003) 56 Stanford Law Review 673 and DG Baird and RK Rasmussen ‘The End of Bankruptcy’ (2002) 55 Stan L Rev 751. 17 One study suggests that in 2002, in more than 80 per cent of all large Chapter 11s, the companies concerned used the process to sell off their assets rather than to reconstruct their debts in the traditional way – see Baird and Rasmussen ‘Chapter 11 at Twilight’ at 674.
- 20. the extent weunderstand the law of corporate reorganizations as providing a collective form in which creditors and their common debtor fashion a future for a firm that would otherwise be torn apart by financial distress, we may safely conclude that its era has come to an end.’ They point to the decline of heavy industry and make the point that success- ful companies today are not very much like the railways of the nineteenth century. In the case of a railroad company, the assets of the firm had very little value when sold off individually – nothing but a streak of rust iron in the prairie, to use a memorable phrase. In the case of a modern capital the most valuable resource may be human capital. The most valuable assets may walk out the door at five or six o’clock in the evening. The accoutrements of the modern office may have just as much value if sold off to another firm than if kept by the debtor: ‘There is no special magic beyond transaction costs in accounting for any particular collection of assets assembled within a single firm.’ In the real world however, transaction costs cannot be ignored. Perhaps Baird and Rasmussen overstate their case.18 Transaction costs are all around us. They exist in almost every move of daily life. Going-concern value resides principally in various relationships ‘among people, among assets, and between peoples and assets’.19 It is tough to start a business from scratch. Networks of relationships are at the heart of a modern business. Costs incurred in creating most of these necessary relationships will inevitably be lost if the business is scattered to the winds through a piecemeal sale of assets. Substantial addi- tional costs will be incurred in the establishment of new relationships and the starting up of a business afresh. Moreover, centralised management, and other benefits from economies of scale, can be the source of going-concern value.20 Introduction 7 18 Even Professor Baird himself seems to acknowledge this implicitly – see the discussion in Elements of Bankruptcy (New York, Foundation Press, 4th ed, 2006) at pp 229–235 and see the comment at p 235: ‘The players in a large corporate reorgani- zation, even those that most resemble the nineteenth-century railroad, no longer see a Hobson’s choice between a sale in an illiquid market or a costly reorganization. Instead, they see the choice as one between selling the business to other investors in a developed, but not perfect, market or keeping it themselves in a proceeding that has become cheaper and easier to control over time.’ 19 L M LoPucki ‘The Nature of the Bankrupt Firm: A Reply to Baird and Rasmussen’s The End of Bankruptcy’ (2003) 56 Stan L Rev 645. 20 See H Miller and S Waisman ‘Does Chapter 11 Reorganization Remain a Viable Option for Distressed Businesses for the Twenty-First Century?’ (2004) 78 Am Bankr LJ 153 at 192–193. ‘Starting a business from scratch is expensive and time- consuming and entails a large degree of entrepreneurial risk.’ Miller and Waisman also make the point that the flurry of recent mergers and acquisitions activity and the move towards consolidation across many industries suggests that there are benefits that cannot be obtained by simply contracting with the marketplace.
- 21. These points havebeen well made by the Legal Department of the International Monetary Fund (IMF), who go so far as suggesting that changes in the nature of the economy have meant that restructuring of ailing firms has become more important than ever before: [I]n the modern economy, the degree to which an enterprise’s value can be maxi- mized through liquidation of its assets has been significantly reduced. In circum- stances where the value of a company is increasingly based on technical know-how and goodwill rather than on its physical assets, preservation of the enterprise’s human resources and business relations may be critical for creditors wishing to maximize the value of their claims. Simply stated, some companies are worth more as going-concerns run by existing managers and with existing shareholders than if sold to third parties and managed by new teams.21 The going-concern surplus may result from the informational advantages of existing management or from the sunk costs of arranging assets in strategic blocks. The surplus has to be substantial, however, to justify the very substantial administrative, negotiating and legal costs of the reorganisation proceedings themselves.22 In the US context, on the other hand, the world of Chapter 11 has changed such that there is now a much greater emphasis on market sales rather than reorganisations in the traditional sense.23 But, contrary to the position that might have appeared during the fall-out from the bursting of the bubble in technology-related shares in 2001/2002, traditional reorganisations have not completely disappeared. There is empirical evidence that reorganisation remains essential for dealing with distressed large public companies.24 Commentators have compared the prices for which 30 large public companies were sold with the values of 30 similar companies that were reorganised in the 2000/2004 period. It was found that companies sold for a 35 per cent average of book value but reorganised for an average fresh value of 80 per cent of book value. Moreover, the average market capitalisation value as determined by post-reorganisation market trading was 91 per cent of book value. ‘Even controlling for the differences in the prefiling earnings of the two sets of companies, sale yielded only half of reorganization value. These results 8 Corporate rescue law – an Anglo-American perspective 21 See D Baird and R Picker ‘A Simple Noncooperative Bargaining Model of Corporate Reorganizations’ (1991) 20 J Legal Studies 311 at 315. 22 Robert Clark ‘The Interdisciplinary Study of Legal Evolution’ (1981) 90 Yale Law Journal 1238 at 1254. 23 See Douglas G Baird ‘The New Face of Chapter 11’ (2004) 12 American Bankruptcy Institute Law Review 69 at 71. 24 Lynn M LoPucki and Joseph W Doherty ‘Bankruptcy Fire Sales’ (2007) 106 Michigan Law Review 1 at pp 3–4.
- 22. suggest that creditorsand shareholders can nearly double their recoveries by reorganizing large public companies instead of selling them.’ Other empirical evidence from the US suggests that Chapter 7 liquidations offer little advantage over Chapter 11 reorganisations. They take almost as long to resolve, require similar fees and ‘in the end provide creditors with lower recovery rates – often zero – than a comparable Chapter 11 procedure.’25 ECONOMIC DISTRESS VERSUS FINANCIAL DISTRESS In commenting on the value of corporate rescue laws it is common to draw a distinction between economic distress and financial distress. Economic distress implies that the business plan is not working. The economic model on which the company is grounded suffers from some flaws. Companies in economic distress are not good candidates for reorganisation unlike companies in financial distress. Financial distress implies liquidity problems of some sort and where a company cannot meet its current liabilities. This may have been caused by some short-term dislocations in market conditions. The bankruptcy of a customer may have affected the company’s capacity to honour its commit- ments to its own suppliers. The company may have been trading across national frontiers and been badly caught out by currency fluctuations. Alternatively, debt-servicing costs may have risen sharply beyond the company’s capacity to service them.26 In the latter scenario an obvious solu- tion (if difficult to achieve in practice) would be to convert some or all of the company’s debt into equity. The necessary consent from creditors may not be forthcoming however and so recourse to formal procedures is necessary to concentrate minds sufficiently. Introduction 9 25 See Arturo Bris, Ivo Welch and Ning Zhu ‘The Costs of Bankruptcy: Chapter 7 Liquidations vs Chapter 11 Reorganizations’ (2006) 61 Journal of Finance 1253 at 1301. See also on Chapter 11 outcomes the bankruptcy research database compiled by Professor Lynn LoPucki available at http://lopucki.law.ucla.edu/. 26 See Richard Posner Economics Analysis of Law (New York, Aspen, 6th ed, 2003) at p 421: ‘. . . the firm may find that its revenues do not cover its total costs, including fixed costs of debt. But they may exceed its variable costs, in which event it ought not be liquidated yet. And maybe in the long run the firm could continue in busi- ness indefinitely with a smaller plant. In that event it might not have to replace all of its debt when that debt was retired, its total costs would be lower, and its (lower) demand and (lower) supply curves might once again intersect. In short, the company may have a viable future, short or long, which it can get to if it can just wipe out its current debt. One way of doing this is to convert that debt into equity capital, at which point the debt will cease being a fixed cost and thus cease preventing the company form meeting its other expenses.’
- 23. While the distinctionbetween economic distress and financial distress may be a useful analytical tool, it may also be a bit blunt at times. The two concepts seem to shade into one another. Although financially distressed businesses are not necessarily in economic distress, a business model that is not working can easily generate liquidity problems and the failure to meet debt-servicing oblig- ations.27 FORMAL AND INFORMAL RESCUE As is made clear throughout this book the emphasis in practice in the UK is on business rescue rather than corporate rescue. Corporate rescue may be achieved through administration coupled with a CVA but this is the outcome in only a small minority of administrations.28 Chapter 11s are more likely to result in a confirmed plan of reorganisation.29 At least in the British context, there is the widespread view that the value of a company is best preserved through informal restructuring or reorganisa- tion procedures.30 The commencement of formal proceedings may cause a 10 Corporate rescue law – an Anglo-American perspective 27 See generally on the distinction and its usefulness Gregor Andrade and Steven N Kaplan ‘How Costly is Financial (No Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed’ (1998) 53 Journal of Finance 1443 and also Douglas G Baird ‘Bankruptcy’s Uncontested Axioms’ (1998) 108 Yale LJ 573 at 580–583. 28 See the empirical study ‘Report on Insolvency Outcomes’ – a paper presented to the Insolvency Service by Dr Sandra Frisby which is available on the Insolvency Service website – www.insolvency.gov.uk. This reports (at p 63) a ‘general view that the only genuine rescue mechanism is the CVA within the protection of administration. Of those rescue outcomes recorded on the database all but two involved CVAs within administration, which would appear to support that view.’ 29 See generally Chapter 3 and in particular Professor Lynn LoPucki’s bank- ruptcy research database – http://lopucki.law.ucla.edu. Professor LoPucki’s book Courting Failure: How Competition for Big Cases is Corrupting the Bankruptcy Courts (Ann Arbor, University of Michigan Press, 2005) in Chapter 4 ‘Failure’contains an extensive account of Chapter 11 plan confirmation rates and refilling rates – see, for example, the tables on pp 100, 101, 113 and 120. Professor Theodore Eisenberg in ‘Business Insolvency Law: Creating an Effective Swedish Reconstruction Law’ (Stockholm, Centre for Business Policy Studies, Occasional Paper No 75, 1995) reports that US Chapter 11 plan confirmation rates decrease with company size: the rate is 96 per cent for companies with assets greater than $100m, 36 per cent for companies with assets between $1m and $100m and 20 per cent for firms with less than $1m in assets. 30 See A Tilley ‘European Restructuring: Clarifying Trans-Atlantic Misconceptions’ [2005] Journal of Private Equity 99 at 102: ‘European restructuring is
- 24. loss of customerconfidence and the disruption of business operations. The importance of achieving the survival of the company without recourse to formal procedures has also been linked to broader social and governmental trends about auditing performance more actively and adopting proactive risk management strategies. Corporate actors are encouraged to see corporate decline as a matter to be anticipated and prevented rather than responded to after the event.31 PRIVATE WORKOUTS IN THE US Out-of-court workouts are common on both sides of the Atlantic, though the ease by which debtors can make use of Chapter 11, and the advantages that Chapter 11 brings, have probably reduced their importance in the US.32 But even in the US it has been suggested that there are often clear advantages in preserving enterprise value by the parties seeking a consensus before a formal Chapter 11 filing. It is perhaps only in situations that are too complex for the stakeholders to reach a negotiated consensus or where the rejection of, what the Americans term, ‘onerous legacy costs’ is crucial that the formal process is used. These are the practicalities that drive the selection of the appropriate process in a particular case.33 Empirical study suggests that Introduction 11 still best achieved out of administration, and with the exception of the U.K. among the major economies, is still inflexible, bureaucratic, and value destructive. For this reason international practitioners favour the U.K. as a jurisdiction should a choice be avail- able.’ See also on the US/European contrast C Pochet ‘Institutional Complementarities within Corporate Governance Systems: A Comparative Study of Bankruptcy Rules’ (2002) 6 Journal of Management and Governance 343; M Brouwer ‘Reorganization in US and European Bankruptcy Law’ (2006) 22 European Journal of Law and Economics 5, and see generally Alice Belcher Corporate Rescue (London, Sweet & Maxwell, 1997) at pp 116–142. 31 See V Finch ‘The Recasting of Insolvency Law’ (2005) 68 MLR 713, and see also V Finch ‘Doctoring in the Shadows of Insolvency’ [2005] JBL 690. 32 See S Gilson ‘Managing Default: Some Evidence on How Firms Choose between Workouts and Chapter 11’ in J Bhandari and L Weiss eds Corporate Bankruptcy: Economic and Legal Perspectives (Cambridge, Cambridge University Press, 1996) p 308. 33 For an argument that the distinction between in-court, and out-of-court, restructuring has become meaningless from a governance perspective see Ethan S Bernstein ‘All’s Fair in Love, War & Bankruptcy? Corporate Governance Implications of CEO Turnover in Financial Distress’ (2006) 11 Stanford Journal of Law, Business and Finance 298. This paper suggests that in 2001 filing for bankruptcy did not change the role of CEO turnover when one controls for financial condition. The shadow of bankruptcy has lengthened making bankruptcy law a central tenet of governance policy regardless of whether a Chapter 11 petition is ever filed.
- 25. private restructuring isgenerally the preferred method of dealing with debtor default.34 Many, if not all, leading banks will have workout divisions. In the US, the machinations of workout bankers have been famously and scatalogically described in the Tom Wolfe novel A Man in Full,35 though more neutrally they are also depicted thus: In marketing they’re incentivized to think of charm and customer satisfaction as value-adding strategies, but not in the workout department. What we’re dealing with now is a division of the bank that has a very narrow niche focus. . . . At the end of the day they know they’re going to be judged by only one thing: how much money they recover for the bank. . . . Down in Texas after the oil crash and all the bankruptcies, the workout people the banks sent in were so niche-focused on that one thing, they started getting death threats. The choice between a private workout and formal bankruptcy proceedings has an obvious parallel with the decision whether or not to litigate or to settle the matter privately out of court.36 If settling privately is appreciably less expensive and/or less time consuming then the parties have an incentive to settle out of court. Nevertheless, if the parties are unable to agree on how to split the cost savings then they will end up in court even though the combined wealth of both parties will be less as a result. The fact that frequent attempts are made to restructure debt privately indi- cates that workouts are less costly on average than Chapter 11 and this analy- sis accords with one’s intuition. Lawyers and investment bankers tend to charge professional fees on an hourly basis and these fees will increase with the length of time that is spent on negotiations with creditors. Private work- outs should be of shorter duration than Chapter 11 restructurings in part because a company need only deal with creditors whose claims are in default rather than with all creditors as is the case under Chapter 11. Moreover, Chapter 11 imposes procedural demands on company managers and this will normally serve to prolong proceedings. A direct comparison on costs between Chapter 11 and private workouts is difficult however, because companies are not required to report the costs of the latter. In addition, calculating the costs of Chapter 11 proceedings has been 12 Corporate rescue law – an Anglo-American perspective 34 For a now somewhat dated study see S Gilson, K John and L Lang ‘Troubled Debt Restructurings: An Empirical Study of Private Reorganization of Firms in Default’ (1990) 27 Journal of Financial Economics 315. 35 New York, Bantam Books, 1999 at p 71. 36 See S Gilson ‘Managing Default: Some Evidence on How Firms Choose between Workouts and Chapter 11’ in J Bhandari and L Weiss eds Corporate Bankruptcy: Economic and Legal Perspectives (Cambridge, Cambridge University Press, 1996) p 308.
- 26. described as measurementsensitive, depending on whether one works on the basis of means or averages or whether one looks to pre-filing or post-filing estimates of corporate value.37 Moreover, a significant number of Chapter 11s start off life as private workouts with companies attempting to reorganise informally. These end up in Chapter 11 when attempts to achieve consensus break down. The available empirical evidence indicates that both shareholders and cred- itors are better off when debt is restructured privately than through Chapter 11.38 Recovery rates for creditors are higher and, in addition, shareholders, typically, are allowed to retain a significantly higher percentage of the equity in workouts than in Chapter 11. In corporate bankruptcy, the so-called absolute priority principle mandates that all classes of creditors should be paid in full before shareholders receive anything. The fact that creditors are prepared to concede greater deviations from the absolute priority principle in private workouts indicates the greater benefits that come to them through avoiding Chapter 11. Creditors are willing to allow shareholders to have a bigger proportion of the cake and this suggests that the overall cake must be that much greater to compensate creditors for the share that they are giving up. Another finding is that private restructurings are more likely to succeed when a higher proportion of the company’s debt is owed to commercial banks and other ‘sophisticated’ investors such as insurance companies.39 These ‘sophisti- cated’ creditors are more likely to recognise the potential benefits of private restructuring than trade creditors. The latter are generally less predisposed to settle their claims. Private workouts become easier when debt is concentrated rather than when a high volume of claims is held by trade creditors. Companies with a greater proportion of trade credit will tend to have recourse to Chapter 11. The rise of distressed-debt trading by vulture funds who buy up trade debt at steep discounts may, in fact, have facilitated debt restructurings.40 Distressed- debt traders, while playing ‘hard ball’ on occasions, will also be anxious to reap a prompt return on the investment and see the advantages in private settlement rather than complicated court proceedings.41 Workouts function better when the creditors are fewer in number and the Introduction 13 37 See Arturo Bris, Ivo Welch and Ning Zhu ‘The Costs of Bankruptcy: Chapter 7 Liquidations vs Chapter 11 Reorganizations’ (2006) 61 Journal of Finance 1253. 38 See J Franks and W Torous ‘A Comparison of Financial Recontracting in Distressed Exchanges and Chapter 11 Reorganizations’ (1994) 35 Journal of Financial Economics 349. 39 Ibid at 366. 40 See B Betker ‘The Administrative Costs of Debt Restructuring: Some Recent Evidence’ (1997) 26 Financial Management 56. 41 See generally Harvey R Miller and Shai Y Waisman ‘Is Chapter 11 Bankrupt’ (2005) 47 Boston College Law Review 129 at 152–154.
- 27. capital structure ofthe company is comparatively straightforward. An increase in the number of creditors adds to the likelihood that any one creditor will hold out and thus make disputes among creditors more likely. Complex capital structures also generate difficulties in terms of putting a value on claims and disagreements amongst creditors over whether they are being treated fairly, relative to other creditors or shareholders. In certain circumstances, recourse to Chapter 11 may have certain advan- tages over private workouts. For instance, a successful workout is dependent on a high level of creditor consensus. If a high proportion of creditors agree to a restructuring plan then there may be enough spare cash or leverage to buy out the dissenters, but if the hold-outs are too great then this option ceases to be a practical possibility. If too many creditors engage in holdouts then the whole project is endangered by this strategic behaviour.42 The Chapter 11 super-majority voting and cramdown rules can overcome holdouts.43 Chapter 11 also contains a stay on creditor enforcement actions which stops a creditor from calling in its debt or enforcing security while restructuring negotiations are in progress.44 The provisions in Chapter 11 for super-priority new finance may also alleviate some funding problems that an ailing company may face.45 Moreover, Chapter 11 contains a mechanism for the rejection of collective bargaining agreements already negotiated by the company and for cuts to be made to retiree health care benefits.46 In other words, a company can shed some of its employment costs in Chapter 11. In American jargon these are onerous legacy costs for rustbelt industries. Wage levels and health benefits must be forced downwards to cope with foreign competition and changes in the nature of the economy. These issues are addressed in more detail in Chapter 7. There is nothing directly equivalent in UK administration, but as one commentator remarks:47 ‘New pensions legislation could be seen to be encouraging a move into UK administration to deflect under-funding liabili- ties to a proposed Government-legislated but industry-funded contingency fund. Legacy issues are not just a preserve of US airlines, it seems.’ 14 Corporate rescue law – an Anglo-American perspective 42 See Horst Eidenmueller ‘Trading in Times of Crisis: Formal Insolvency Proceedings, Workouts and the Incentives for Shareholders/Managers’ (2006) 7 European Business Organization Law Review 239 at 254–255 who suggests the impo- sition of cooperation duties on creditors. 43 S 1129 of the Bankruptcy Code. 44 S 362. 45 S 364. 46 Ss 1113 and 1114. 47 See A Tilley ‘European Restructuring: Clarifying Trans-Atlantic Misconceptions’ [2005] Journal of Private Equity 99 at 102.
- 28. PRE-PACKS In the US,in the early 1990s there were some obstacles hindering out-of-court restructurings in the shape of an unfavourable judicial ruling and a change in the tax code that penalised out-of-court debt forgiveness. These hindrances were eventually overcome48 but, in the meantime, ‘pre-packs’ developed as a response.49 The rise and development of ‘pre-packs’ – both pre-packaged Chapter 11s and pre-packs in the context of administrations are discussed more fully in later chapters. Suffice it to say here that pre-packs aim to combine the speed, flexibility, and some of the cost advantages, of out-of- court restructuring with the facility for overcoming ‘hold-outs’ among minor- ity creditors that Chapter 11 or administration offers. They are one solution to the hold-out problem. The pre-packaged Chapter 11 or administration is more or less a done deal before it formally begins with the main steps being chore- ographed in advance and then recourse is had to the formal procedure to carry them through. There are mixed views on pre-packs. According to one study:50 On most measures considered, prepacks lie between out-of-court restructurings and traditional Chapter 11 reorganizations. Accordingly, it is tempting to conclude that a prepack is a more efficient mechanism for resolving financial distress than a tradi- tional Chapter 11 reorganization, but less efficient than out-of-court restructuring. Unfortunately, because the firms in our sample have chosen to reorganize by means of a prepack (presumably because that represents the most efficient form of reorga- nization for the firm), that conclusion is unwarranted. Thus, our study, like those that precede it, is unable to resolve the question of whether one form of reorgani- zation is more efficient than another. Other assessments would suggest that possible efficiency gains are more than cancelled out by loss of valuable protections for minority creditors and share- holders WORKOUTS IN THE UK In the UK, an important empirical study preceding the Enterprise Act has Introduction 15 48 See B Betker ‘An Empirical Examination of Prepackaged Bankruptcy’ (1995) 24 Financial Management 4 and see also A Belcher Corporate Rescue at p 125. 49 See J McConnell and H Servaes ‘The Economics of Pre-packaged Bankruptcy’ in J Bhandari and L Weiss eds Corporate Bankruptcy: Economic and Legal Perspectives (Cambridge, Cambridge University Press, 1996) p 322. 50 See generally E Tashjian, RC Lease and JJ McConnell ‘Prepacks: An Empirical Analysis of Prepackaged Bankruptcies’ (1996) 40 Journal of Financial Economics 135 at 137.
- 29. highlighted the existenceof an elaborate rescue process outside formal proce- dures.51 According to this study: About 75% of firms emerge from rescue and avoid formal insolvency procedures altogether (after 7.5 months, on average). Either they are turned-around or they repay their debt by finding alternative banking sources. . . . Turnarounds are often accompanied by management changes, asset sales, and new finance or directors’ guarantees. There is evidence that these changes significantly influence the bank’s response and the likelihood of a successful outcome. Leading lenders may be able to use their leverage to force distressed compa- nies to restructure, whether by means of downsizing, management replace- ment or otherwise. Moreover, the willingness of the company to restructure is significantly related to the size of debt repayments demanded by the bank. During the restructuring period however, the evidence also indicates that the exposure of the bank is substantially reduced whereas the debts due to trade and other creditors tend to expand. Trade creditors bear the major part of the risk associated with the restructuring process as they do not share the bank’s knowledge of the company’s financial position and their lending is unse- cured. In the 1980s, the Bank of England developed a set of principles – the ‘London Approach’ – for multi-lender corporate workouts and these guide- lines became public by means of publications from Bank officials. The Bank of England’s interest in corporate workouts stemmed from its core responsi- bilities relating to the maintenance of financial stability and the promotion of an effective and efficient financial system.52 The ‘London Approach’ involved a willingness by the main creditors to consider a non-statutory resolution of a company’s financial difficulties, the commissioning of an independent review of the company’s long-term viability and the operation of an informal morato- 16 Corporate rescue law – an Anglo-American perspective 51 See J Franks and O Sussman ‘The Cycle of Corporate Distress, Rescue and Dissolution: A Study of Small and Medium Size UK Companies’ (2000). This study was sponsored by the DTI/Treasury Working Group on Company Rescue and Business Reconstruction Mechanisms. See also Cook, Pandit and Milman ‘Formal Rehabilitation Procedures and Insolvent Firms: Empirical Evidence on the British Company Voluntary Arrangement Procedure’ (2001) 17 Small Business Economics. See also the policy document ‘Banks and Businesses Working Together’ from the British Bankers Association website – www.bba.org/. 52 On the ‘London Approach’ see generally P Brierley and G Vlieghe ‘Corporate Workouts, the London Approach and Financial Stability’ [1999] Financial Stability Review 168; P Kent ‘Corporate Workouts – A UK Perspective’ (1997) 6 International Insolvency Review 165; J Flood, R Abbey, E Skordaki and P Aber The Professional Restructuring of Corporate Rescue: Company Voluntary Arrangements and the London Approach (1995) ACCA Research Report No 45.
- 30. rium on creditorenforcement procedures during the review period. The main creditors try to arrive at a joint view about whether, and on what terms, the company is worth supporting on a long-term basis and a coordinating, or lead, bank may be designated to facilitate these discussions. Generally, the lead bank will be the bank with the largest exposure to the company and it is usually also the bank with whom the company has its main banking relation- ship. Creditors form a steering committee and this constitutes a forum to which some decisions by lenders can be delegated. During the review period, the existing credit facilities are maintained in place by the lenders and, in addition, they may provide supplemental lending if there is a need for further liquidity support. This new finance may come from one or more of the existing lenders and normally assumes priority over existing exposures. If the company is deemed to be viable on a long-term basis by the financial review and there is support for this among creditors, then the creditors will consider longer-term arrangements such as extending loan repayment periods, providing additional financial support or converting debt into equity. Creditors may also be asked to consider a so-called ‘haircut’, i.e. an element of debt forgiveness. As a condition of gaining the cooperation and support of its creditors, the company will usually have to implement an agreed business plan and this may entail management changes, the sale of assets or divisions, or even the acceptance of a takeover bid. The role of the Bank of England may have diminished in multi-creditor corporate workouts, if indeed it ever played a significant role at all apart from acting as a general ‘honest broker’. The rise of hedge funds, debt trading and the general fragmentation of the financial markets has caused perceptions of the Bank’s role to alter but nevertheless, all market participants are acquainted with the fact that a company with its business operations intact is much more valuable than a company whose customers have fled elsewhere on the commencement of formal proceedings.53 In the US there has been nothing equivalent to the semi-official status of the London Approach for multi-lender debtor workouts but a shared set of expec- tations among lenders towards debtor default undoubtedly exists based on a community of interests. Introduction 17 53 See generally J Armour and S Deakin ‘Norms in Private Bankruptcy: the “London Approach” to the Resolution of Financial Distress’ [2001] Journal of Corporate Law Studies 21.
- 31. PRIVATE WORKOUTS –AN INTERNATIONAL PERSPECTIVE On the international level, INSOL, an international organisation of insolvency practitioners, has developed a statement of principles for multi-lender debtor workouts.54 While not reproducing the exact detail and somewhat more limited in nature, the statement of principles reflects the broad thrust of the London Approach. The IMF in its study of insolvency and debtor protection regimes has acknowledged the importance that informal restructuring mechanisms can play in a holistic approach towards corporate insolvency.55 Nevertheless, it stressed that informal procedures were not, for a number of reasons, the exclu- sive answer to corporate distress. For a start, out-of-court procedures required the unanimous consent of creditors, which was not always available given the scope for prisoners’ dilemma-type game playing. Secondly, it was important to encourage recourse to the restructuring option at an appropriately early stage – before it was too late – and formal procedures could be designed with this objective in mind. Thirdly, ‘economic efficiency is not the only consider- ation when designing insolvency laws’. Formal procedures could provide the opportunity to investigate corporate misbehaviour, reverse questionable trans- actions and investigate the causes of the debtor’s financial failure. Informal ‘rescues’ are clearly not the perfect solution for every economic ill of a company.56 There is the hold-out problem and moreover, private rescues may narrow the focus too much onto the immediate concerns of the company and its bank creditors. Other constituencies may deserve a say in the restructuring process. Formal procedures can bring these interests into play in a way that informal procedures do not. WIDER PURPOSES SERVED BY CORPORATE RESCUE LAWS In many jurisdictions, including the US and UK, discussion of the purposes served by corporate rescue laws has ranged beyond a narrow focus on the going-concern surplus over liquidation value of company assets.57 This 18 Corporate rescue law – an Anglo-American perspective 54 See the INSOL website – www.insol.org/. 55 Orderly & Effective Insolvency Procedures: Key Issues (Washington, IMF, 1999) at pp 13–15. 56 See Alice Belcher Corporate Rescue at p 127. 57 See, for example, Karen Gross Failure and Forgiveness: Rebalancing the
- 32. perspective emerges froma consideration of the US Congressional record on the Bankruptcy Code: ‘The purpose of a business reorganization case, unlike a liquidation case, is to restructure a business’s finances so that it may continue to operate, provide its employees with jobs, pay its creditors and provide a return for its stockholders.’58 Outside the congressional context, Chapter 11 has even been spoken of as bound up with the preservation of the American way of life. The argument is that Chapter 11 provides the opportunity for the small business debtor to survive economic upheaval and to remain in existence business-wise. If jobs in small business enterprises disappear, then competition and convenience may disappear with them.59 In the UK, the DTI review of company rescue and business reconstruction mechanisms60 referred to the fact that: many countries have enacted changes to their insolvency law in an attempt to reduce the number of businesses and companies that are liquidated. Generally this has been done in order to ameliorate the consequences of the unfettered operation of the market (e.g. where the pursuit by creditors of their own individual interests would have led to the liquidation of businesses and companies.) And in particular (but not exclusively) where there are substantial implications for employment (i.e. to save jobs). These themes have also been taken up by the IMF,61 which has spoken of corporate rehabilitation procedures as serving a broader societal interest in that business debtors are given a second chance, thereby encouraging the growth of the private sector and an entrepreneurial class. More general, the IMF has acknowledged that:62 Introduction 19 Bankruptcy System (New Haven, Yale University Press, 1997) and see also E Warren and JL Westbrook ‘Contracting out of Bankruptcy: An Empirical Intervention’ (2005) 118 Harvard Law Review 1197 at 1200–1201 who suggest that the current insolvency regimes limit ‘the collection rights of each creditor individually in order to promote a somewhat more efficient liquidation or reorganization for the benefit of all concerned. This is accomplished by shrinking the collection rights of the most powerful creditors in order to achieve somewhat greater distribution among all those who have a stake in the debtor’. 58 HR Rep No 595, 95th Congress, Ist Sess 220 (1977). 59 James B Haines and Philip J Hendel ‘The Future of Chapter 11: No Easy Answers: Small Business Bankruptcies after BAPCPA’ (2005) 47 B.C.L. Rev 71 at 92 ‘We know this from common experience in the retail industry. When the small, local business disappears, consumers are left largely with the regional megastores. Less competition usually results in higher prices and poorer service.’ 60 London, DTI, 2000 at p 5. 61 Orderly & Effective Insolvency Procedures: Key Issues (Washington, IMF, 1999). 62 Ibid at p 14. According to the IMF (at p 15): ‘While it is generally recognized
- 33. There are socialand political factors that are served by the existence of formal reha- bilitation provisions and, in particular, the protection of employees of a troubled enterprise. These considerations explain why the design of rehabilitation provisions varies from country to country. When countries evaluate and reform their insol- vency laws, the key question will often be how to find the appropriate balance between a variety of social, political, and economic interests that will induce all actors in the economy to participate in the system. Coming from the IMF, this admission is worthy of note.63 From the legislative record in both the US and UK, as well as in the opin- ion of international organisations like the IMF, there are considered to be important goals of corporate rescue law other than the preservation of a going- concern surplus. Apart from maximising returns to creditors, corporate rescue law is seen as also helping to preserve employment; encouraging the creation and development of an entrepreneurial class of business people and facilitat- ing national strategic objectives such as maintaining choice for the consumer and keeping alive national champions that might otherwise fall victim to foreign competition. There is a degree of ambiguity, however, about whether the preservation of employment and the other identified objectives should be seen as independent goals of corporate rescue law or merely incidental bene- fits that come from rescue proceedings and the preservation of the going- concern surplus. 20 Corporate rescue law – an Anglo-American perspective that rehabilitation procedures are necessary, statistics show that, at least in a number of countries, up to 90 per cent of insolvency proceedings end up in liquidation. Yet, statis- tics may be misleading. They often fail to capture the fact that larger companies (which have a greater impact on the economy) are more likely to be rehabilitated. Moreover, the failure of rehabilitation in these circumstances may often be due to the inadequate design or application of the rehabilitation procedure, and the conversion of rehabilita- tion into liquidation may reflect the fact that an enterprise with no chance of rehabili- tation has used the rehabilitation procedure solely as a means of forestalling liquidation.’ 63 For a searing criticism of the IMF see the international bestseller by Joseph Stiglitz Globalization and Its Discontents (New York, Penguin, 2002) and the comment at pp 12–13: ‘Over the years since its inception, the IMF has changed markedly. Founded on the belief that markets often worked badly, it now champions market supremacy with ideological fervor. Founded on the belief that there is a need for inter- national pressure on countries to have more expansionary economic policies – such as increasing expenditures, reducing taxes, or lowering interest rates to stimulate the economy – today the IMF typically provides funds only if countries engage in policies like cutting deficits, raising taxes, or raising interest rates that lead to a contraction of the economy.’
- 34. WIDER INTERESTS VERSUSTHE CREDITORS’ BARGAIN PERSPECTIVE ON CORPORATE RESCUE LAWS There are many theorists and policy makers who hold to the view that the preservation of employment, etc. should be an independent goal of corporate rescue law. In the main, these commentators argue that the law should seek to protect employment and general community interests as well as providing equity among creditors. On this analysis, a ‘rehabilitated’ company provides benefits to a variety of external constituencies including the government in the form of more taxes. Existing and future employees also benefit, either in the form of continued or new employment and/or higher salary levels. Local communities too may benefit, in that the wealth in the locality is increased due to the presence of the reorganised and now profitable company. From this perspective, and bearing in mind the wider public benefits, it is not unreason- able to expect that secured creditors should bear some of the costs of reorgan- isation. In other words, secured creditors should not necessarily be compensated for any delay in enforcing their security interest attendant on the rescue proceedings. Moreover, secured creditors might be forced to accept a reorganisation plan against their wishes. On the other hand, this ‘wider perspectives’ view of bankruptcy and corpo- rate reorganisation law has been rejected forcibly in the US by many scholars, particularly those from the ‘law and economics’ camp. For example, Professors Jackson, Baird and Scott have advanced the creditors’ bargain theory,64 under which the costs of reorganisation should not be imposed on secured creditors who do not benefit from reorganisation but, instead, be imposed on the company itself and on unsecured creditors who may benefit. Creditors’ bargain theorists see insolvency law as being designed to solve collective action problems,65 or to express the point differently, a race among Introduction 21 64 See Thomas H Jackson The Logic and Limits of Bankruptcy Law (Cambridge, MA, Harvard University Press, 1986); ‘Bankruptcy, Non-Bankruptcy Entitlements and the Creditors’ Bargain’ (1982) 91 Yale LJ 857; DG Baird and TH Jackson ‘Corporate Reorganizations and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy’(1984) 51 U Chi Law Review 97; Thomas H Jackson and Robert E Scott ‘An Essay on Bankruptcy Sharing and the Creditors’ Bargain’ (1989) 75 Va L Rev 155. 65 See Jackson Logic and Limits of Bankruptcy Law at p 10: ‘The basic problem that bankruptcy law is designed to handle, both as a normative matter and as a positive matter, is that the system of individual creditor remedies may be bad for the creditors as a group when there are not enough assets to go around. Because creditors have conflicting rights, there is a tendency in their debt-collection efforts to make a bad situ- ation worse.’
- 35. creditors to collectavailable assets from an ailing company may lead to the premature dismemberment of the company and the destruction of value. Under the race and grab model, actions by individual creditors would harm the cred- itors as a group. Insolvency law, on the other hand, can ensure a larger aver- age return for creditors by preserving a company’s going-concern value. Mixing metaphors, insolvency law is seen essentially as a response to a common pool problem in that creditors fishing individually in a common pool may deplete or exhaust the stock of fish to the detriment of the group as a whole.66 In a company where there are diverse interests, and individual creditors have different packages of rights, these creditors have an incentive to take actions that will increase their own share of the assets even if, in so doing, they reduce the aggregate value of the company.67 In the creditors’ bargain scheme of things, insolvency law, at its core, is designed to prevent individual creditor actions against assets from interfering with the use of those assets that is in the best interests of creditors as a group. Insolvency law requires persons to act collectively rather than taking individual actions that may harm the group of creditors.68 The cornerstone of the creditors’ bargain theory is the normative claim that pre-insolvency entitlements should not be impaired in insolvency except where this is necessary to maximise net asset distributions to the cred- itors as a group. Pre-insolvency entitlements should never be impaired to accomplish purely distributional goals.69 Insolvency law exists solely for the benefit of creditors and shareholders and the interests of employees, suppliers, customers and communities should be taken into account only to the extent that particular members of those constituencies are creditors with enforceable legal rights against company assets under general law. ‘To take any other inter- est of those constituencies into account would constitute prima facie theft.’70 Basically, concerns that arise outside the insolvency sphere should not be addressed by changing insolvency policy.71 22 Corporate rescue law – an Anglo-American perspective 66 See Jackson, ibid at p 12: ‘What is required is some rule that will make all hundred fishermen act as a sole owner would. That is where bankruptcy law enters the picture in a world not of fish but of credit.’ 67 DG Baird and TH Jackson ‘Corporate Reorganizations and the Treatment of Diverse Ownership Interests: A comment on adequate protection of secured creditors in bankruptcy’ (1984) 51 U Chi Law Review 97 at 105. 68 Ibid. 69 Thomas H Jackson and Robert E Scott ‘An Essay on Bankruptcy Sharing and the Creditors’ Bargain’ at 159. 70 See Charles W Mooney ‘A Normative Theory of Bankruptcy Law: Bankruptcy As (Is) Civil Procedure’ (2004) 61 Washington and Lee Law Review 931 at 964. 71 See the comment in Jackson Logic and Limits of Bankruptcy Law at p 25:
- 36. According to thecreditors’ bargain theory, if one protects the rights that a secured creditor enjoys outside insolvency this reinforces the insolvency law objectives about putting a company’s assets to their best use.72 The costs of corporate rescue procedures are placed on those who stand to benefit from such procedures. Otherwise, they will be encouraged to invoke and prolong such procedures. Insolvency rules that enable shareholders and junior credi- tors to gain from company rescue, while avoiding the full costs of making the rescue attempt, are seen as creating inappropriate incentives. There is the risk that the company will fail and if the choice between liquidation and reorgani- sation is not to be skewed, the argument is that those who benefit from a possi- ble upswing of company fortunes should bear the risk of failure.73 A rule which provides secured creditors with the full value of their existing propri- etary rights is not seen as preventing desirable reorganisations but, instead, it encourages junior creditors and shareholders to pay for rescue opportunities that benefit them. The creditors’ bargain view of the world contains a central contractarian core based on the normative premise that insolvency law should generally reflect the hypothetical agreement that creditors would reach if they were to bargain amongst themselves before extending credit to the company.74 The terms of the hypothetical bargain are regarded as efficient because those terms represent the product of unfettered bargaining among property owners. Once derived in this way, the terms of the hypothetical bargain stand as a critique of the corresponding provisions of insolvency law. The analysis assumes that the parties bargained solely on the basis of entitlements that are created by the general law applying outside the insolvency framework and did not bargain from any entitlements created under insolvency law.75 In its role as a collective Introduction 23 ‘Incorporating such a policy in a bankruptcy statute, however, would be to mix apples and oranges, if one accepts the view (as everyone seems to) that bankruptcy law also exists as a response to a common pool problem.’ 72 DG Baird and TH Jackson ‘Corporate Reorganizations and the Treatment of Diverse Ownership Interests’, at 103. 73 DG Baird and TH Jackson, ibid at 108–109. 74 Jackson in Logic and Limits of Bankruptcy Law at p 17 fn 22 suggests that this is an application of the famous Rawlsian notion of bargaining in the ‘original position behind a veil of ignorance’ – see John Rawls A Theory of Justice (New Haven, Yale University Press, 1971) at pp 136–142. But for claims that Jackson got Rawls wrong see Donald R Korobkin ‘Contractarianism and the Normative Foundations of Bankruptcy Law’ (1993) 71 Texas Law Review 541; RJ Mokal Corporate Insolvency Law: Theory and Application (Oxford, Oxford University Press, 2005) at pp 61–62. 75 See the comments of the US Supreme Court in Butner v US (1979) 440 US 48 at 54–55: ‘Property interests ae created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analysed differently simply because an interested party is involved in a bankruptcy
- 37. debt-collection device, insolvencylaw should not create rights but instead act to ensure that pre-existing rights are vindicated to the greatest extent possible.76 Critics, however, have complained that it is hard to see how the idea of a notional bargain among creditors could form the basis of a rational system of insolvency law.77 Professor Sir Roy Goode, for one, speculates that if one could imagine a situation in which all creditors, secured and unsecured, were to come together to decide what was to happen in the event of disaster, would it not be likely that unsecured trade suppliers, on having brought home to them as a group the relative vulnerability of their position, would insist on a slice of the corporate cake as a condition of their co-operation?78 The creditors’ bargain theory is ultimately based on some conception of what parties will do in practice in the real world. Nevertheless, the parties are only figments of a theoretician’s imagination with all the imaginary attributes ascribed to them by their creator. The creator is conceiving certain character- istics and then investing the characters with these qualities. Such fictional features may not have any necessary relationship with the qualities of actual creditors.79 The academic papers developing the creditors’bargain model were original and thoughtful but ‘there was an eerie sort of abstraction about them. I always felt about Baird and Jackson on bankruptcy a little like I feel about Henry James on love: remarkable stuff, but can you trust an author who doesn’t seem to know how babies are made?’80 In the real world, creditors do not act collectively in taking decisions and consequently, we have no true idea of how they would proceed or the sorts of factors that they would bring to bear on the decision-making process. Where there is no actual agreement among creditors, an individual creditor cannot be sure what other creditors will do.81 24 Corporate rescue law – an Anglo-American perspective proceeding. Uniform treatment of property interests by both state and federal courts within a State serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving a windfall merely by reason of the happenstance of bankruptcy.’ 76 See Jackson Logic and Limits of Bankruptcy Law at p 22 77 See also Andrew Keay ‘Insolvency Law: A Matter of Public Interest?’ (2000) 51 NILQ 509 at 527: ‘It is glib to say, as those outside the discipline may and some insolvency law commentators such as Professor Jackson do, that insolvency law only deals with economics and is only concerned with the plight of persons who have not been paid what they are owed.’ 78 See Roy Goode Principles of Corporate Insolvency Law (London, Thomson, 3rd ed, 2005) at p 47. 79 See Goode, ibid at p 46. 80 See John D Ayer (2004) 12 American Bankruptcy Institute Law Review 101. 81 But see however, D Webb ‘An Economic Evaluation of Insolvency Procedures in the United Kingdom: Does the 1986 Insolvency Act Satisfy the Creditors’ Bargain’ (1991) 43 Oxford Economic Papers 139.
- 38. THE PROCEDURAL THEORYOF INSOLVENCY AND CORPORATE RESCUE LAW The creditors’ bargain theory undoubtedly has its critics but, nevertheless, the underlying idea of respecting pre-insolvency entitlements has gained renewed vigour in the form of procedure theory. Procedural theorists assert as a cardinal principle that insolvency law should maximise recoveries and benefits for those with rights against a company’s assets, but subject to the constraints that are consistent with the rationale for having an insolvency law.82 The theory draws its normative force from substantive law that applies outside the insolvency sphere. It assumes that insolvency law, as part of the law of civil procedure, should not undermine these substantive rules of law based on conflicting policy views. Unless special treatment in insolvency can be justified on a basis or context peculiar to insolvency, general legal policies necessarily are undermined if persons other than ‘rights-holders’are given special treatment in insolvency to the detriment of ‘rights-holders’. The same is true if the interests of ‘rights-hold- ers’ are diminished or enhanced for the benefit of, or at the expense of, other ‘rights-holders’ in a manner that is inconsistent with the general legal frame- work.83 Procedure theory is generally dismissive of an insolvency system that would create a special reordering of the interests of ‘rights-holders’ in the insol- vency context. Procedural law, including insolvency law, should advance, enhance and vindicate policies that the general legal framework creates, and seeks to implement, but should not disrupt such policies.84 Advocates of procedure theory suggest that service to extraneous interests at the expense of, or in a way that involves risk to, ‘rights-holders’ is prima facie theft. A judicial proceeding that transfers wealth from those who are legally entitled to benefit from that value to those who hold no legal entitle- ment is wrong. Sympathetic as an extraneous cause employment, rehabilita- tion or community may appear, redistribution of wealth in bankruptcy away from those who hold legal entitlements to those who do not, whether to further a political agenda or a communitarian philosophy or otherwise, is a corruption of civil justice. Robin Hood was after all a crook.85 Introduction 25 82 See generally Charles W Mooney ‘A Normative Theory of Bankruptcy Law: Bankruptcy As (Is) Civil Procedure’ at 931. 83 Ibid at 943–944. 84 See Steven L Harris and Charles W Mooney ‘Revised Article 9 Meets the Bankruptcy Code: Policy and Impact’ (2001) 9 American Bankruptcy Institute Law Review 85 at 87–89: ‘The Bankruptcy Code offers a blank check to the makers of non- bankruptcy law to define and delineate property law principles that will prevail in Bankruptcy.’ 85 See Charles W Mooney ‘A Normative Theory of Bankruptcy Law: Bankruptcy As (Is) Civil Procedure’ at 964–965.
- 39. The procedural schoolalso suggests that the secured creditor’s property rights should not be sacrificed for the benefit of the unsecured creditors, and where secured creditors are prevented from enforcing their collateral during rescue proceedings without being provided with full compensation, the effect ‘is not merely wrong, it is outrageous’.86 On the other hand, critics may think that it is over-simplistic to suggest that insolvency law is, or should be, merely about protecting pre-insolvency enti- tlements. Certain issues come to the fore during the insolvency process and it is only right that these should be addressed during that process. Directorial misconduct is one such issue and, under s 7(4) Company Directors Disqualification Act, the administrator is obliged to report to the DTI Director Disqualification Unit whether the director’s conduct in relation to the company in administration renders him unfit to be concerned in company management in the future. One could devise a system under which a director’s conduct could be examined at any point during the company’s history with a view to ascertaining whether disqualification was an appropriate response. Implementation of such a system would necessitate a massive bureaucracy however, and confining the disqualification option to situations where a company enters a formal insolvency process seems a defensible pragmatic response.87 Professor Goode makes the point that certain problems confronting claimants outside the common pool creditors arise specifically because of the company’s insolvency and for no other reason. ‘[T]o treat bankruptcy law as confined to creditors confronting the common pool problem is surely to prejudge the very question in issue. It is also wholly inconsistent with insol- vency laws around the world, all of which include provisions for claimants outside the common pool creditors.’88 26 Corporate rescue law – an Anglo-American perspective 86 Ibid at 641. The point is also made by Jackson Logic and Limits of Bankruptcy Law at 189. 87 For a less extreme proceduralist theory of bankruptcy law see E Brunstad and M Sigal ‘Comparative Choice Theory and the Broader Implications of the Supreme Court’s Analysis in Bank of America v 203 North LaSalle Street Partnership’ (1999) 54 Business Lawyer 1475 text accompanying 234 ‘Bankruptcy law does not exist in a vacuum, nor does it operate in one. Rather, it operates against a backdrop of pre-exist- ing legal structures. These structures are important because . . . they govern commer- cial relations generally, and care must be taken to avoid bankruptcy rules that alter commercial expectations in ways that generate more harm than good. This does not mean . . . that bankruptcy law should never modify commercial procedures. In many instances, modifications are necessary to promote the goals of the Chapter 11 regime. But it does not follow that all non-bankruptcy norms are, therefore, irrelevant, or should be ignored simply because a firm files for bankruptcy relief.’ 88 See Goode Principles of Corporate Insolvency Law at p 45. But see Jackson Logic and Limits of Bankruptcy Law at p 26: ‘Bankruptcy law cannot both give new
- 40. Professor Goode alsoasks the rhetorical question that, since it is conceived to be beneficial to bring all creditors within a collective proceeding for the common benefit of creditors, ‘why should it not be equally beneficial to require creditors as a class to co-operate as part of a wider class of beneficia- ries that would include employees and shareholders as regards interests and expectations beyond their pre-bankruptcy entitlements?’89 Under UK law, certain preferential claims are accorded preferential status and in an administration, receivership or liquidation, are to be paid out of float- ing charge recoveries in priority to the floating charge holder where there are insufficient ‘free’ assets of the company to satisfy the claims in full.90 Moreover, under a regime introduced by the Enterprise Act a proportion of floating charge recoveries are set aside for the benefit of unsecured creditors.91 In defence of these provisions and their ‘insolvency-specific’nature, one could argue that all creditors expect to be paid in full.92 There is no point in enact- ing a law that would apply outside the insolvency context which confers pref- erential creditors with priority over floating charge holders because all debts should be satisfied in full by the company. The legislature created a specific set of insolvency entitlements with full knowledge of the existence and content of non-insolvency entitlements and with the intention of departing from the latter. Secured creditors can hardly complain because all that a court is doing is applying a pre-existing rule of law to a specific case. There is noth- ing that is being taken from the creditor because at the time that the security arrangement was made, the secured creditor knew or should have known that its rights were circumscribed by the legislation.93 If property rights are defined by reference to existing law then no ‘taking’ has occurred. It can hardly be Introduction 27 group rights and continue effectively to solve a common pool problem. Treating both as bankruptcy questions interferes with bankruptcy’s historic function as a superior debt-collection system against insolvent debtors. Fashioning a distinct bankruptcy rule – such as one that gives workers rights they do not hold under nonbankruptcy law – creates incentives for the group advantaged by the distinct bankruptcy rule to use the bankruptcy process even though it is not in the interest of the owners of the group.’ 89 Goode Principles of Corporate Insolvency Law at p 45. 90 Ss 40 and 175 Insolvency Act 1986. 91 S 176A Insolvency Act 1986. 92 For a different viewpoint see John Armour ‘Should We Redistribute in Insolvency’ in J Getzler and J Payne eds Company Charges: Spectrum and Beyond (Oxford, Oxford University Press, 2006). 93 See generally J Rogers ‘The Impairment of Secured Creditors’ Rights in Corporate Reorganisation: A Study of the Relationship Between the Fifth Amendment and the Bankruptcy Clause’ (1983) 96 Harv L Rev 973 and for a different, more ‘pro- property’ perspective see DG Baird and TH Jackson ‘Corporate Reorganisation and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy’ (1984) 51 Uni of Chi L Rev 97.
- 41. suggested that thereis a prohibition on even purely prospective restrictions on secured creditors. Otherwise, one would be making the assumption that the property rights held by secured creditors are in some sense anterior to positive law, and that is an extreme proposition.94 MORE INCLUSIVE ‘BARGAIN’ MODELS There are, of course, bargain theories of insolvency law suggesting that regard should be had to non-creditor interests. For instance, Professor Korobkin has propounded a normative framework for insolvency law based on a hypotheti- cal bargain as devised by the representatives of all interests that might by affected by a debtor’s financial distress. On this model, the bargainers all know they may be affected by the insolvency, but no one knows if s/he will be a debtor, an unsecured creditor whether contractual or involuntary, a secured creditor, an ordinary employee, a member of the community that is otherwise unconnected to the debtor company or somebody in a different kind of rela- tionship. Korobkin suggests that this inclusive hypothetical group would seek to protect those who are rendered most vulnerable by the insolvency and come up with something approximating to the major features of current US bank- ruptcy law.95 With more specific relevance to the UK, this inclusive hypothetical bargaining model has been developed by Dr Rizwaan Mokal into an ‘authen- tic consent model (ACM)’ which aims to analyse and justify the principles of insolvency law.96 The authentic consent model also extends participation in 28 Corporate rescue law – an Anglo-American perspective 94 The European Convention on Human Rights (incorporated in domestic English law through the Human Rights Act 1998) provides in Article 1 of the First Protocol: ‘Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of inter- national law.’ Article 1 adds however, that the preceding prescriptions do not in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties. Article 1 was considered by the House of Lords in Wilson v First Country Trust Ltd (No 2) [2004] 1 AC 816 in the context of the Consumer Credit Act 1974; on which see generally J De Lacy ‘Company Charge Avoidance and Human Rights’ [2004] JBL 448. 95 For the exposition of Professor Korobkin’s theory see ‘Rehabilitating Values: A Jurisprudence of Bankruptcy’ (1991) 91 Columbia Law Review 717; ‘Contractarianism and the Normative Foundations of Bankruptcy Law’ (1993) 71 Texas Law Review 541; ‘The Role of Normative Theory in Bankruptcy Debates’ (1996) 82 Iowa Law Review 75. 96 See RJ Mokal ‘The Authentic Consent Model: Contractarianism, Creditors’
- 42. the imaginary negotiationprocess to parties other than creditors but, at the same time, focuses intensely on what makes insolvency law special.97 The model is founded on an idea of ‘dramatic ignorance’. To this end, it identifies peculiar insolvency issues and gathers together all the parties affected by these issues. It then imbues them with the constructive attributes it claims democratic society expects of its citizens as legislators . . . The ACM requires all insolvency principles to be agreed to by all the relevant parties. But this agreement must not be extracted under conditions of Natural Ignorance. It must be fair, entered into under appropriate circumstances. It must be based on the premise that parties are free and equal, and it must not allow some of them to dominate others because of strength, financial clout or superior bargaining skill.98 The model regards all parties to the imaginary negotiation process as being free and equal as well as being reasonable and rational.99 Consequently, the principles chosen would be fair and just. In real-life negotiations however, the parties may not be blessed with these ideal qualities. Moreover, individual conceptions of fairness or justice may differ very considerably depending on one’s political, philosophical or religious beliefs. It has been said quite power- fully that ex ante hypothetical bargain theories of insolvency law, however elegantly dressed up, are open to the objection that they amount to little more than an argument that thoughtful, interested, objective and neutral lawmakers would come to the proponent’s conclusions about insolvency.100 Such models tend to assume an original position in which the various players act in an economically rational manner according to a single set of criteria. Persons Introduction 29 Bargain and Corporate Liquidation’ (2001) 21 Legal Studies 400; Corporate Insolvency Law: Theory and Application (Oxford, Oxford University Press, 2005) chapters 2 and 3. Dr Mokal is however, rather critical of Korobkin, stating in Corporate Insolvency Law at p 64 that the latter’s ‘expansive benevolence is arbitrary and misguided. Korobkin’s grand, imperialistic vision of insolvency law results from a rather simple error. Somewhere along the way, he stops asking himself: What makes insolvency law special?’ 97 See Corporate Insolvency Law (2005) at p 70 fn 41 ‘Those invited to partici- pate in the choice position here are all parties affected by corporate insolvency in a unique way. The interests to be protected are interests either threatened only in the debtor’s insolvency, or threatened by it in a manner peculiar to insolvency. The cate- gories of such interests are unlikely to be wide.’ 98 See RJ Mokal ‘The Authentic Consent Model’ at 430. 99 Corporate Insolvency Law: Theory and Application (Oxford, Oxford University Press, 2005) at p 87. Dr. Mokal insists that what separates the creditors’ bargain theory from the authentic consent model is not a narrow slit consisting of dissimilar types of uncertainty but a ‘wide chasm of profound philosophical differ- ences’. 100 See generally Charles W Mooney ‘A Normative Theory of Bankruptcy Law’ at 966, whose comments were framed with particular reference to Korobkin’s theory.
- 43. however tend tomake decisions on the basis of more than merely economic considerations. Furthermore, a series of presuppositions can hardly replicate the complex realities of business life or the many possible decision makers and the matrix of circumstances in which decisions have to be reached.101 TEAM PRODUCTION THEORY One of the implicit assumptions of the creditors’ bargain theory seems to be that there is a common pool of assets against which creditors have a pre-insol- vency claim. But this not in fact the case. Rather, creditors expect to be paid from the anticipated stream of income produced by the ongoing enterprise.102 Building on this insight, and also theories of corporate law more generally,103 Professor Lynn LoPucki has recently developed a team production theory of corporate reorganisation law.104 Under team production theory, corporate reor- ganization is viewed not as a regulation imposed by government but instead becomes an implicit agreement under which creditors and shareholders agree to subordinate their legal rights to the preservation of the company as a going- concern. Preservation of the company as a going-concern may require that the company honour team production obligations by giving these obligations priority over legal obligations. It is suggested that the theory is solidly grounded on actual contracts entered into by team members but is also norma- tive in its assertion that actual contracts should be enforced because they are efficient. Under the team production theory as it applies to corporate law generally, the so-called ‘teams’delegate to a company’s board of directors ulti- mate authority over both the direction of the enterprise and distribution among team members of production rents and surpluses. The team comprises all those members who make company-specific investments, including those who are unable to protect those investments by direct contracting, personal trust or reputation. Team production theory invokes the legislative history of the US Bankruptcy Code which suggests that the purpose of Chapter 11, unlike liqui- dation, is to restructure a company’s business operations so that it may 30 Corporate rescue law – an Anglo-American perspective 101 See Goode Principles of Corporate Insolvency Law at pp 46–48. 102 See Axel Flessner ‘Philosophies of Business Bankruptcy Law: An International Overview’ in Jacob Ziegel ed Current Developments in International and Comparative Corporate Insolvency Law (Oxford, Clarendon Press, 1994) 19 at pp 25–26. 103 See generally Margaret Blair and Lynn Stout ‘A Team Production Theory of Corporate Law’ (1999) 85 Virginia Law Review 247. 104 LoPucki ‘A Team Production Theory of Bankruptcy Reorganization’ (2004) 557 Vand L Rev 741.
- 44. continue to operate,provide its employees with jobs, pay its creditors, and produce a return for shareholders.105 It is better to reorganise than to liquidate because reorganisation preserves jobs and assets. The team production theory sees preservation of the corporate entity as an independent value that partially accounts for this choice of reorganisation over liquidation. The greater inclu- siveness of the team production theory is also said to minimise the externali- sation of company costs.106 Many of the social costs incurred in the creation of a corporate entity have been borne by employees, communities, suppliers, customers and others. When a company fails, then prima facie those parties are left with the costs. The team production theory suggests that those costs which have been incurred by anyone in reasonable reliance on the team production arrangements should be internalised by the company. The theory was formulated with reference to the United States insolvency system and it may be more congruent with that system than with its UK equiv- alent.107 For example, the US Chapter 11 is based on the concept of debtor-in- possession with the board of directors remaining in control of the company’s affairs during the reorganisation process. In carrying out their management functions, the board of directors continue to be governed by the ‘business judgment’ rule which gives directors wide latitude in all matters connected with the operation of the business. Moreover, influential judicial statements in the US emphasise that, in the vicinity of insolvency, the board of directors have an ‘obligation to the community of interests that sustained the corpora- tion to exercise judgment in an informed good faith effort so as to maximise the corporation’s long-term wealth creating capacity’.108 Debtor-in-possession is a feature of Chapter 11 that may be accounted for by team production theory but not so easily by the creditors’ bargain theory. One might rhetorically ask Introduction 31 105 See the comments in the US House of Representatives HR Rep No 95–595, p 220 (1977) ‘The purpose of a business reorganization case, unlike a liquidation case, is to restructure a business’s finances so that it may continue to operate, provide its employees with jobs, pay its creditors, and produce a return for its stockholders . . . It is more economically efficient to reorganize than to liquidate, because it preserves jobs and assets.’ 106 LoPucki ‘A Team Production Theory of Bankruptcy Reorganization’ at 770. 107 On the other hand, employee rights are better protected in the UK through the general employment law framework and in the case of business transfers by the EC Acquired Rights Directive implemented in the UK by the Transfer of Undertakings (Protection of Employment) Regulations generally known as TUPE. These matters are discussed in more detail in Chapter 7. The effect of the legislation is to bring about a statutory novation of contracts of employment from an insolvent employer to a solvent transferee. 108 Credit Lyonnais Bank Nederland NV v Pathe Communications No CIV.A. 12130, 1991 Del. Ch. LEXIS 215 at 108–109 referred to by LoPucki above, n 104 at 758.
- 45. that if thereorganisation procedure is to serve only the interests of creditor- owners, why should a board of directors elected by the shareholders remain in control of the company?109 In the UK, by contrast, administration operates as a management displacement device with the administrator assuming the management tasks formerly entrusted to the board of directors.110 The two systems differ also with regard to reorganisation plans. In the US, a class of creditors, including secured creditors, can be forced by the court to accept a reorganisation plan through a mechanism known as ‘cram down’, even though creditors are theoretically protected by the so-called absolute priority rule and by the ‘best interests of creditors’ test.111 The absolute prior- ity rule means that the reorganisation plan must follow the scheme of priorities established by the law. The ‘best interests of creditors’ test applies in favour of each individual creditor and shareholder and requires that they should receive at least as much under the reorganisation plan as they would receive in a liquidation of the company under Chapter 7 of the US Bankruptcy Code.112 While liquidation values do establish a floor, a reorganisation plan has considerable latitude with regard to the distribution of the going-concern surplus.113 In the UK, on the other hand, there is less flexibility about propos- 32 Corporate rescue law – an Anglo-American perspective 109 See LoPucki ‘A Team Production Theory of Bankruptcy Reorganization’ at 768. 110 On the relative merit of debtor-in-possession versus management displace- ment insolvency regimes see D Hahn ‘Concentrated Ownership and Control of Corporate Reorganisations’ (2004) 4 JCLS 117. See also V Finch ‘Control and co-ordi- nation in corporate rescue’ [2005] Legal Studies 374; O Brupbacher ‘Functional Analysis of Corporate Rescue Procedures: A Proposal from an Anglo-Swiss Perspective’ (2005) 5 JCLS 105. 111 On cram down see Jack Friedman ‘What Courts do to Secured Creditors in Chapter 11 Cram Down’ (1993) 14 Cardozo Law Review 1496 who suggests at 1499 that ‘the traditional mystique concerning cram down which instills fear among secured creditors is exaggerated. Cram down is applied in a remarkably homogenous and predictable manner regarding secured claims.’ 112 See generally s1129 of the US Bankruptcy Code. 113 See the views expressed in the US Congress about entitlements to the ‘surplus’ value produced by a liquidation case – ‘The parties are left to their own to negotiate a fair settlement. The question of whether creditors are entitled to the going- concern or liquidation value of the business is impossible to answer . . . Instead, nego- tiation among the parties after full disclosure will govern how the value of the reorganizing company will be distributed among creditors and stockholders. The bill only sets the outer limits on the outcome: it must be somewhere between the going- concern value and the liquidation value’ – HR Rep No 595, 95th Cong, 1st Sess 224 (1977). For a slightly different perspective see Omer Tene ‘Revisiting the Creditors’ Bargain: The Entitlement to the Going-Concern Surplus in Corporate Bankruptcy Reoganizations’ (2003) 19 Bankruptcy Developments Journal 287 at 326 ‘Chapter 11 is a forum for structured bargaining among classes of investors. Bankruptcy law should
- 46. als in anadministration or in a company voluntary arrangement. Such propos- als cannot affect adversely the rights of a secured creditor to enforce its secu- rity without its consent.114 Ultimately, under the team production theory, team members repose trust in the board of directors ‘to do the right thing’ with regard to the distribution of corporate goods. While the theory may have considerable explanatory force in the US context, this appeal is lacking in the UK given the management displacement nature of administration. Moreover, even advocates of the theory seem uncomfortable about some of its aspects since the theory is based on a wholesale grant of unfettered power to the board of directors.115 MULTIPLE VALUES OR ECLECTIC APPROACHES It has been suggested that a single unifying theory of corporate rescue law, while intellectually and theoretically attractive, cannot adequately explain the phenomenon. Moreover, one should not judge corporate rescue law against a single criterion or theory. The point has been made in forceful terms by Professor Elisabeth Warren who states:116 A simple economic analysis of bankruptcy is clear, straightforward and always promises to yield firm answers to hard questions. The fact that the economic analy- sis is utterly self-referential also spares the proponent from nasty hours searching out empirical evidence or trying to learn about what happens in real borrowing and lending decisions. And the assumptions themselves are garbed in neutral terms, lending an aura of fairness to the development of policy. Introduction 33 not determine the claimants’ substantive rights and entitlements, but rather preserve the respective values of the parties’ rights at the commencement of a case. Instead of divid- ing the unallocated GCS among classes of claimants, bankruptcy should provide unbi- ased procedural rules allowing the parties to negotiate on level ground. The claimants will distribute among themselves the surplus created in reorganization, that is, the GCS. While secured creditors may receive a portion of the GCS as a result of these negotia- tions, they should not obtain such value by virtue of bankruptcy law itself.’ 114 Insolvency Act 1986 Schedule B1 para 73. 115 See the comments by Lynn LoPucki ‘A Team Production Theory of Bankruptcy Reorganization’ at 778. ‘Team Production is not a theory with which I feel comfortable. The theory is based on a wholesale grant of unfettered power to directors. My inclination is to think that will not work. Power corrupts and absolute power corrupts absolutely. The almost daily reports of director fraud, negligence, and indis- cretion in the newspapers confirms my inclination. Only a fool would trust corporate directors.’ 116 ‘Bankruptcy Policy’ (1987) 54 U Chicago L Rev 775 at 812.
- 47. In her view,single theories run a great risk of providing answers that may be quite sensible within a confined, abstract scheme but that will not work in a complex reality.117 Professor Warren puts forward what she terms a ‘dirty, complex, elastic, interconnected view of bankruptcy from which outcomes cannot be predicted, nor all the factors relevant to a policy decision necessarily fully articulated.’118 She sees insolvency law as an attempt to reckon with a company’s multiple defaults and to distribute the consequences of such defaults among a number of different actors. The law encompasses a number of compet- ing – and sometimes conflicting – values in this distribution process. Solving the collective action problems facing creditors should not be taken as the sole intellectual yardstick, with insolvency law being judged exclusively as good, or bad, depending on whether it promotes, or impairs, creditor collectivism. Professor Warren has identified four principal goals of the insolvency system: to enhance the value of an ailing company; to distribute that value according to multiple normative principles; to internalise costs of business failure among parties dealing with the company and finally, to promote reliance on private monitoring arrangements.119 In her view however, the insolvency regime only protects in an indirect fashion the interests of parties without formal legal rights. It does this largely through provisions that permit businesses to reorganise instead of being shut down by a few anxious credi- tors.120 Moreover, the system encourages entrepreneurial endeavour and risk- taking in that if the opportunity for corporate reorganisation exists, companies that pursue high risk but potentially rewarding strategies can survive some short-term dislocations and have a greater chance of seeing their risk-taking strategies pay off.121 The existence of a rescue regime also insulates the government to a degree from pressure to fund bailouts for individual business failures.122 34 Corporate rescue law – an Anglo-American perspective 117 Ibid at 811. 118 Ibid at 775. 119 ‘Bankruptcy Policymaking in an Imperfect World’ (1993) 92 Michigan Law Review 336 at 344. 120 Ibid at 356. 121 Ibid at 358: ‘If investors perceived that businesses in some financial trouble faced immediate liquidation, they would likely have two responses: they would not invest their money to start businesses, or they would direct their business investments toward less risky enterprises. To the extent that reorganisation alternatives exist, companies that pursue risky alternatives have the opportunity to survive some short- term dislocations and a greater chance to see their risk-taking strategies pay off. At the margins, any law permitting reorganisation of a business increases the likelihood of survival of companies through troubled times, which makes risk-taking more attrac- tive.’ 122 Ibid at 361.
- 48. The multiple valuesor eclectic approach towards evaluating insolvency law has in turn been criticised for vagueness, uncertainty and indeterminacy. The multiple values approach may be unable to provide concrete standards for judging concrete cases or proposals. For example, little assistance is offered to decision-makers on the management of tensions and contradictions between different values or on the way that trade-offs between various ends should be carried through. In addition, there are no core principles to determine trade-off or to establish weightings.123 A variant on the multiple values approach is to set out, explicitly, various values or benchmarks for evaluating insolvency and corporate rescue law. This approach is favoured by Professor Finch who suggests that the legitimacy of the processes and principles of insolvency law can be tested by reference to four benchmarks, namely: efficiency, expertise, accountability and fairness.124 There has been criticism of this benchmarking approach however, largely because of a perceived failure to distinguish between substantive and proce- dural goals.125 Substantive goals are those which justify the existence of this part of the law by showing it in its best light while procedural goals, on the other hand, are about how the law goes about attaining its substantive goals. Simply stated, a distinction should be drawn between the ultimate ends of the law, and the methods that the law adopts in attempting to achieve those ends: ‘Once a set of substantive goals has been exogenously specified (e.g. using a theory of justice) [procedural goals] can be used to judge between various proposed schemes for implementing it.’ Applying this analysis, the benchmarks of efficiency, expertise and accountability are largely about means and not ends. Consequently, ‘fairness’ is left standing as the sole substantive goal and bears a heavy burden of analy- sis and explanation.126 On the other hand, if one adds ‘justice’ to the mix and then proceeds to examine corporate rescue law from the perspective of justice as well as fairness, this may not lead us any closer in the direction of provid- ing specific proposals or solutions for specific situations.127 Perhaps, the best Introduction 35 123 See Vanessa Finch ‘The Measures of Insolvency Law’ (1997) 17 OJLS 227 at 241. 124 See generally V Finch, ibid; Vanessa Finch Corporate Insolvency Law: Perspectives and Principles (Cambridge, Cambridge University Press, 2002). 125 See the review article by RJ Mokal ‘On Fairness and Efficiency’ (2003) 66 MLR 452 and see also RJ Mokal Corporate Insolvency Law: Theory and Application (Oxford, Oxford University Press, 2005) at p 67 fn 31. 126 Vanessa Finch in ‘The Measures of Insolvency Law’ (1997) 17 OJLS 227 at 252 acknowledges that trade-offs ‘between different rationales do remain a problem but . . . the absence of easy answers has to be accepted when dealing with processes whose essence is the balancing of multiple objectives.’ 127 RJ Mokal in Corporate Insolvency Law: Theory and Application develops an
- 49. approach in tryingto resolve uncertainty is to establish a clear hierarchy of values or objectives. THE OBJECTIVES OF CORPORATE RESCUE LAW AND THE LEGISLATIVE RECORD Chapter 11 and UK administrations are similar, yet distinct, procedures in many ways. Moreover, with both procedures it is submitted that there is an element of obfuscation at their heart. If one examines the legislative history in both the UK and US it becomes apparent that there is some degree of ambi- guity about the respective merits of reorganisation versus liquidation of ailing enterprises and about the interests that corporate reorganisation law should protect. It is difficult to escape the conclusion that, at times at least, this ambi- guity is deliberate and serves to obscure or gloss over difficult choices between potentially competing goals. In the influential Cork committee report which led to the UK Insolvency Act 1986 there is at least a bow in the direc- tion of goals other than creditor wealth maximisation. The committee suggested that the aims of a good modern insolvency law included recognis- ing that ‘the effects of insolvency are not limited to the private interests of the insolvent and his creditors, but that other interests of society or other groups in society are vitally affected by the insolvency and its outcome, and to ensure that these public interests are recognized and safeguarded’.128 The committee also talked about providing ‘means for the preservation of viable commercial enterprises capable of making a useful contribution to the economic life of the country . . .’.129 On the other hand, administration, as revamped by the Enterprise Act 2002, appears to have creditor wealth maximisation at its core, although this core is well disguised since corporate rescue is ostensibly placed at the top of the legislative tree. It is provided that an administrator’s functions must be performed with the objective of (a) rescuing the company as a going concern, or (b) achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being in admin- istration), or (c) realising property in order to make a distribution to one or 36 Corporate rescue law – an Anglo-American perspective ‘authentic consent’ model to explain and justify insolvency law based on fairness and justice as recognised in conditions of dramatic ignorance. 128 Report of the Review Committee on Insolvency Law and Practice (Cmnd 8558, 1982) at para 198(i). 129 Ibid at para 198(j). On the other hand, the subsequent White Paper A Revised Framework for Insolvency Law (Cmnd 9175, 1984) focused on the interests of credi- tors.
- 50. more secured orpreferential creditors.130 An administrator can only descend this statutory hierarchy of objectives if s/he thinks that it is not reasonably practicable to achieve any of the preceding objectives even though an admin- istrator has to move from (a) to (b) if he thinks that (b) would achieve a better result for the company’s creditors as a whole. While the administrator cannot act solely in the interests of a creditor who may have initiated the administra- tion process, producing better returns for company creditors appears, at the end of the day, to be essentially what administration is about.131 The first objective stated in the legislation (though not necessarily the primary objective) is rescuing the company as a going-concern. The parlia- mentary debates make it clear that this objective is about preservation of the business of the company rather than preservation of the company as an empty corporate shell.132 The government stressed: ‘We would not want the admin- istrator to rescue the company if it is to the detriment of creditor value.’133 In many cases an administrator may reach a rapid conclusion that a sale of assets achieves a better result for company creditors than preserving the busi- ness of the company as a going concern. There seems little scope for chal- lenging an administrator’s judgement on this matter although it is provided in Schedule B1 para 74 Insolvency Act that a creditor or member may complain to the court that the administrator is acting, or has acted, so as unfairly to harm the interests of the applicant and/or others, or is proposing to act in such a manner. Moreover, the administrator has a duty, in the statement setting out proposals for achieving the purpose of administration, to explain why the ‘rescue’ objective cannot be achieved, and this statement may provide some ammunition to form the basis of a court challenge.134 The relevant test though, is what the administrator ‘thinks’ and not what s/he ‘reasonably believes’. Introduction 37 130 Insolvency Act 1986 Schedule B1 para 3(1). An administrator must also perform his/her functions in the interests of the company’s creditors as a whole – para 3(4)(b). 131 See S Frisby ‘In Search of a Rescue Regime: The Enterprise Act 2002’ (2004) 67 MLR 247 at 262 and more tentatively Vanessa Finch ‘Control and Co-ordination in Corporate Rescue’ [2005] Legal Studies 374 at 395–396: ‘The terms of EA 2002 mean that it is arguable that an administrator is obliged to pursue a going-concern sale where he thinks this will serve creditors better than efforts made to rescue the company – even where it might be possible to rescue the company. Primacy is accordingly given to maximising overall returns to creditors, rather than to rescue per se.’ See also D Prentice ‘Bargaining in the Shadow of the Enterprise Act 2002’ (2004) 5 European Business Organization Law Review 153 at 158. 132 See the comments by Lord Hunt of Wirral in the House of Lords – HL debates col 765, 29 July 2002. 133 See the comments by the relevant Minister, Lord McIntosh of Haringey, in HL Debates col 766, 29 July 2002. 134 Schedule B1 para 49(2)(b).
- 51. While the stateof a person’s mind may be as much a fact as the state of the person’s digestive tract, the ‘thinks’ test leaves little scope for judicial review.135 It is not generally the practice of the courts to second-guess the commercial judgements of administrators and other discretionary decision- makers. It was explained during the parliamentary debates:136 The administrator is the person on the ground who is best placed to judge whether or not a particular objective is reasonably practicable, in the light of his experience and professional judgment. . . .[I]t will be for the administrator to reach a conclu- sion as to whether or not the objectives are reasonably practicable, taking into account all the circumstances of the particular case of which he or she is aware at the time. The emphasis placed in the legislation on the administrator’s opinion may make judicial intervention virtually impossible provided that the opinion has been formed in good faith.137 One commentator suggests138 the likely practical effect of the paramount regard to what is in the best interest of the company’s creditors as a whole is that there will be a few instances where the administrator performs his functions with the objective of rescuing the company as a going concern. After all, the interests of creditors are more often than not to be paid as much as possible, and as quickly as possible. Those primarily interested in a rescue are likely to be employees, guarantors of any debts of the company and shareholders, interests to which the administrator is not expressly required to have regard. The overarching general requirement that an administrator should not unnecessarily harm the interests of company creditors as a whole139 may go some of the way towards allowing limited second-guessing of administrators’ decisions in certain contexts. An example is where a company has two assets; one of which is essential to the carrying on of a company’s business but the other is not essential. The administrator then decides to sell the key asset, perhaps because it is a bit more easily saleable, so as to make distributions to secured and preferential creditors even though the sale has a crippling effect 38 Corporate rescue law – an Anglo-American perspective 135 For somewhat different perspectives see J Armour and R Mokal ‘Reforming the Governance of Corporate Rescue: The Enterprise Act 2002’ [2005] LMCLQ 28; R Mokal and J Armour ‘The New UK Rescue Procedure – The Administrator’s Duty to Act Rationally’ (2004) I International Corporate Rescue 136; M Simmons ‘Enterprise Act and Plain English’ [2004] Insolvency Intelligence 76. 136 Hansard, HL Deb, col 768, 29 July 2002. 137 See Finch ‘Re-Invigorating Corporate Rescue’ [2003] JBL 527 at 546. 138 See Lisa Linklater ‘The Enterprise Act: Fulfilling Great Expectations’ (2003) 24 Company Lawyer 225. 139 Schedule B1 para 3(4).
- 52. on the furtherviability of the company’s business. In these circumstances, it would seem that the administrator has acted in a way that has unfairly and unnecessarily harmed the interests of company members and creditors. Therefore this action may be challenged under para 74, whereas it seems that if an administrative receiver had behaved in a similar fashion, this conduct could not be impeached.140 Underlying the revised administration procedure appears to be the princi- ple that if there are ‘alternative courses of action, one of which will benefit creditors only, and another which, with a little delay, will confer benefits on employees and shareholders without significant detriment to the creditors, then it is a legitimate function of insolvency law to have regard to those wider interests’.141 The interests of employees and shareholders, and indeed wider community interests, may be subordinate to those of creditors, but they have their place in the overall scheme of things. This policy is reflected in UK law as it applies to solvent companies. The appointment of an administrator displaces the board of directors from their management functions but the directors are responsible for running the company until the administrator takes their place. The formulation of director’s duties in the Companies Act 2006 provides that a director must act in the way s/he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.142 In fulfilling the statutory duty it is specifically stated that a director must have regard to: Introduction 39 140 An administrative receiver can choose to exercise or not to exercise the power of sale over a particular asset. According to the Privy Council decision in Downsview Nominees v First City Corp [1993] AC 295 the only constraint on the administrative receiver’s choices is the criterion of good faith. In the words of Professor Sir Roy Goode in Principles of Corporate Insolvency Law at pp 284–285) Downsview suggests that: ‘The receiver . . . is entitled, if he so chooses, to decide not to continue the company’s business, and to sell a part of the business which would be better kept. It would also seem that he can select a particular asset to realise for the benefit of his debenture holder even though the removal of that asset would damage the company’s business and there are other assets to which he could resort and on which the business is less dependent.’ 141 See Roy Goode Principles of Corporate Insolvency Law at p 45. 142 The Company Law Reform Steering Group in ‘Modern Company Law for a Competitive Environment: The Strategic Framework’ (March 1999) at pp 39–46 set forth two alternatives. One is that of maintaining what they consider to be the existing directorial duty of following enlightened shareholder interests. The second alternative is that of creating a ‘pluralist’ duty to all major stakeholders. See generally on what interests corporate law should serve, Henry Hansmann and Reinier Kraakman ‘The End of History for Corporate Law’ in Jeffrey Gordon and Mark Roe ed Convergence and Persistence in Corporate Governance (Cambridge, Cambridge University Press, 2004) p 33.
- 53. a. the likelyconsequences of any decision in the long term, b. the interests of the company’s employees, c. the need to foster the company’s business relationships with suppliers, customers and others, d. the impact of the company’s operations on the community and the envi- ronment, e. the desirability of the company maintaining a reputation for high stan- dards of business conduct, and f. the need to act fairly as between members of the company.’143 In the US, when the Bankruptcy Code was promulgated in 1978, there was great emphasis placed on corporate reorganisation. This point has been noted in caustic terms by one commentator:144 Few free market law and economics scholars were around to make the cruel argu- ment that society would prosper if the free market were allowed to kill off weak and inefficient companies. That the dismissed workers of a dead company might be better off in the long run as a result of that death (or that a competitor’s workers would be) was hardly considered. The incantation, ‘reorganization, yes, liquidation, no’ echoed through the . . . Halls of Congress. Firms should be given every chance to save their goodwill; no one seems to have thought much of the firms with badwill that could be liquidated for a greater sum than they would command as going concerns, nor did anyone seem to believe that a large percentage of firms that would use chapter 11 might possess badwill, not good. So even in 1978 . . . the right was a pale and moderate version of its later self, and many of the arguments one might hear from the law and economics crowd today were but whispers then. In the Congressional debates on the Bankruptcy code, there are discussions 40 Corporate rescue law – an Anglo-American perspective 143 S 172(1) Companies Act 2006. S 172(2) provides that where ‘or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes.’ According to the Explanatory Notes accompanying the Company Law Reform Bill which became the Companies Act 2006 this provision enshrines in statute what is commonly referred to as the principle of enlightened shareholder value. The statutory list of factors is said to highlight ‘areas of particular importance which reflect wider expectations of responsible business behaviour’. See generally on this area John Parkinson ‘Inclusive Company Law’ in John De Lacy ed The Reform of UK Company Law (London, Cavendish, 2002) at p 43 who suggests that the priority afforded to shareholders ‘reflects not so much a belief that their interests are inherently more deserving of protection than those of other groups, as acceptance of the traditional economic analysis that argues that the greatest contribution to “wealth and welfare for all” is likely to be made by companies with a primary shareholder focus.’ 144 See the comments in James J White ‘Death and Resurrection of Secured Credit’ (2004) 12 American Bankruptcy Institute Law Review 139.
- 54. of policies toprotect public investors, safeguard jobs and to help save troubled businesses. Concerns were raised about the community impact of bankruptcy and the wider public interest that extended beyond the narrow realm of the parties in conflict. The legislature, it appears, intended the Bankruptcy Code to address issues that were broader than the immediate problems of the debtor company and affected creditors.145 This sentiment was picked up by the US Supreme Court in NLRB v Bildisco146 who said: ‘The fundamental purpose of reorganization is to prevent a debtor from going into liquidation, with an attendant loss of jobs and possible misuse of economic resources.’ Analysis of these observations however, reveals an ambiguity. It is unclear whether saving businesses is primarily about improving the position of creditors or maintaining the status of owner-managers or preserving employment. What if there is a conflict between these objectives? Should the objective of creditor wealth maximisa- tion be accorded ascendancy even if it means the sacrifice of employment opportunities? Is employment preservation a separate and independent goal of corporate rescue law or rather something that in the ordinary course of events will come about if returns to creditors are improved? While a careful reading of the record may reveal that the latter alternative most closely reflects the views of the legislature, employment preservation was certainly highlighted as a desirable benefit of a well-crafted corporate rescue law. In recent years however, the mood music has changed and the objective of maximising creditor recoveries has come to assume a greater prominence. Asset sales have begun to predominate rather than reorganisations in the tradi- tional sense. Whereas the debtor and its manager seemed to dominate bankruptcy only a few years ago, Chapter 11 now has a distinctively creditor-oriented cast. Chapter 11 no longer functions like an anti-takeover device for managers; it has become, instead, the most important new frontier in the market for corporate control, complete with asset sales and faster cases.147 CONCLUSION The US Supreme Court has described the objectives of Chapter 11 in the following terms:148 Introduction 41 145 See Karen Gross ‘Finding Some Trees but Missing the Forest’ (2004) 12 American Bankruptcy Institute Law Review 203 at fn 47. 146 (1983) 465 US 513 at 528. 147 See David A Skeel Jr ‘Creditors’ Ball: The “New” New Corporate Governance in Chapter 11’ (2003) 152 U Pa L Rev 917 at 918. 148 US v Whiting Pools Inc (1983) 462 US 198 at 203. See also HR Rep No 595,
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- 56. Then, as ifto change the subject, she crossed to my side, and pointing to an antique ivory cross upon an ebony stand, much battered and yellow with age, which I had picked up in a shop on the Ponte Vecchio, in Florence, long ago, she exclaimed— “What a quaint old crucifix!” And she took it up and examined it closely, as a connoisseur might look at it. “The figure, I see, is in silver,” she observed. “And it is very old. Italian, I should say.” “Yes,” I replied, rather surprised at her knowledge. “How did you know that?” But she smiled, and declared that she only guessed it to be so, as I had half an hour ago spoken of a recent winter spent in Italy. Then, after admiring it, she placed it down, and again turned, sighed heavily, and bent over the Directory, which was still open upon the table. As she did so, she suddenly burst forth— “At last! I’ve found it. Look! there can be no mistake. It isn’t Ellerdale Street, but Ellerdale Road!” And bending beside her I read where she pointed with her slim finger the words, “16, Popejoy, Mrs” “Is that your aunt’s name?” I asked. “Yes,” she replied. “And yours?” I asked.
- 57. But she pursedup her lips and did not seem inclined to impart this knowledge to me. “My name is really of no account,” she said. “We shall not meet again.” “Not meet again?” I cried, for the thought of losing a friend so beautiful and so charming was an exceedingly unhappy one. “Why shall we not meet? You are going to live in London now, you say,” and taking a card from my cigarette- case I handed it to her. With her clear, brilliant eyes fixed upon mine, she took the card almost mechanically, then glanced at it. “I’m greatly indebted to you, Mr Cleeve,” she said. “But I don’t see there is any necessity for you to know my name. It is sufficient, surely, for you to reflect that you one night befriended one who was in distress.” “But I must know your name,” I protested. “Come, do tell me.” She hesitated, then lifted her eyes again to mine and answered— “My name is Aline.” “Aline,” I repeated. “A name as charming as its owner.” “You want to pay me compliments,” she laughed, blushing deeply. “And your surname?” I went on. “Cloud,” she replied. “Aline Cloud.”
- 58. “Then your aunt’sname is Popejoy, and you are living at 16, Ellerdale Road, Hampstead,” I said, laughing. “Well, we have discovered it all at last.” “Yes, thanks to you,” she replied, with a sigh of relief. Then looking anxiously at the clock, she added, “It’s late, therefore I must be going. I can get there in a cab, I suppose?” “Certainly,” I answered; “and if you’ll wait a moment while I get a thick coat I’ll see you safely there—if I may be allowed.” “No,” she said, putting up her little hand as if to arrest me, “I couldn’t think of taking you out all that way at this hour.” I laughed, for I was used to late hours at the club, and had on many a morning crossed Leicester Square on my way home when the sun was shining. So disregarding her, I went into my room, exchanged my light overcoat for a heavier one, placed a silk muffler around my neck, and having fortified myself with a whiskey and soda, we both went out, and entering a cab started forth on our long drive up to Hampstead. The cabman was ignorant of Ellerdale Road, but when I directed him to Fitzjohn’s Avenue he at once asserted that he would quickly find it. “I hope we may meet again. We must!” I exclaimed, when at last we grew near our journey’s end. “This is certainly a very strange meeting, but if at any time I can render you another service, command me.” “You are extremely good,” she answered, turning to me after looking out fixedly upon the dark, deserted street, for
- 59. rain was falling,and it was muddy and cheerless. “We had, however, better not meet again.” “Why?” I inquired. Her beauty had cast a spell about me, and I was capable of any foolishness. “Because it is unnecessary,” she replied, with a strange vagueness, yet without hesitation. We were passing at that moment the end of a winding thoroughfare, and at a word the cabman turned his horse and proceeded slowly in search of Number 16. Without much difficulty we found it, a good-sized detached house, built in modern style, with gable ends and long windows; a house of a character far better than I had expected. I had believed the street to be a mean one, of those poor-looking houses which bear the stamp of weekly rents, but was surprised to find a quiet, eminently respectable suburban road at the very edge of London. At the back of the houses were open fields, and one or two of the residences had carriage-drives before them. There was still a light over the door, which showed that the lost one was expected, and as she descended she allowed her little, well-gloved hand to linger for a moment in mine. “Good night,” she said, merrily, “and thank you ever so much. I shall never forget your kindness—never.” “Then you will repay me by meeting me again?” I urged. “No,” she answered, in an instant serious. “It is best not.” “Why? I trust I have not offended you?”
- 60. “Of course not.It is because you have been my friend to- night that I wish to keep apart from you.” “Is that the way you treat your friends?” I inquired. “Yes,” she replied, meaningly. Then, after a pause, added, “I have no desire to bring evil upon you.” “Evil!” I exclaimed, gazing in wonderment at her beauty. “What evil can you possibly bring upon me?” “You will, perhaps, discover some day,” she answered, with a hollow, artificial laugh. “But I’m so very late. Good night, and thank you again so much.” Then turning quickly, with a graceful bow she entered the gate leading to the house, and rang the bell. I saw her admitted by a smart maid, and having lit a fresh cigarette settled myself in a corner, and told the cabman to drive back to Charing Cross Mansions. The man opened the trap-door in the roof of the conveyance, and began to chat, as night-cabmen will do to while away the time, yet the outlook was very dismal—that broad, long, never-ending road glistening with wet, and lit by two straight rows of street-lamps as far as the eye could reach right down to Oxford Street. I was thinking regretfully of Aline; of her grace, her beauty, and of the strange circumstances in which we had become acquainted. Her curious declaration that she might cause me some mysterious evil sorely puzzled me, and I felt impelled to seek some further explanation. I entered my chambers with my latch-key, and the ever- watchful Simes came forward, took my hat and coat, drew
- 61. forward my particulararmchair, and placed the whiskey and syphon at my elbow. I had mixed a final drink, and was raising my glass, when suddenly my eyes fell upon the little triangular side-table where the curios were displayed. What I saw caused me to start and open my eyes in amazement. Then I walked across to inspect it more closely. The ivory crucifix, the most treasured in my collection, had been entirely consumed by fire. Nothing remained of it but its ashes, a small white heap, the silver effigy fused to a mass. “Simes!” I cried. “What’s the meaning of this?” “I don’t know, sir,” he answered, pale in alarm. “I noticed it almost the instant you had left the house. The ashes were quite warm then.” “Are you sure you haven’t had an accident with it?” I queried, looking him straight in the face. “No, sir; I swear I haven’t,” he replied. “Your cab had hardly driven away when I found it just as it is now. I haven’t touched it.” I looked, and noted its position. It was in the exact spot where Aline had placed it after taking it in her hand. I recollected, too, that it was there where she had seen the object which had so disturbed her. That some deep and extraordinary mystery was connected with this sudden spontaneous destruction of the crucifix was plain. It was certainly an uncanny circumstance.
- 62. I stood beforethat little table, my eyes fixed upon the ashes, amazed, open-mouthed, petrified. A vague, indefinite shadow of evil had fallen upon me.
- 63. Chapter Three. Woman’s World. Themore I reflected, the greater mystery appeared to surround my pretty acquaintance of that well-remembered evening. Three days went by, and, truth to tell, I remained in an uncertain, undecided mood. For a year past I had been the closest friend and confidant of Muriel Moore, but not her lover. The words of love I had spoken had been merely in jest, although I could not disguise from myself that she regarded me as something more than a mere acquaintance. Yet the strange, half-tragic beauty of Aline Cloud was undeniable. Sometimes I felt half-inclined to write to her and endeavour to again see her, but each time I thought of her, visions of Muriel rose before me, and I recollected that I admired her with an admiration that was really akin to love. On the third evening I looked in at the St. Stephen’s Club, finding Roddy stretched in one of the morocco-covered chairs in the smoking-room, with a long whisky and soda on the table by his side. “Hullo!” he cried gaily, as I advanced, “where did you get to the other night?” “No, old fellow,” I answered, sinking into a chair near him; “ask yourself that question. You slipped away so very quickly that I thought you’d met some creditor or other.” “Well,” he answered, after a pause, “I did see somebody I didn’t want to meet.”
- 64. “A man?” Iasked, for my old chum had but few secrets from me. “No; a woman.” I nodded. At that instant a thought occurred to me, and I wondered whether Roddy had encountered Aline, and whether she was the woman he did not wish to meet. “Was she young?” I asked, laughing. “Not very,” he replied vaguely, adding, “There are some persons who, being associated with the melancholy incidents in one’s life, bring back bitter memories that one would fain forget.” “Yes, yes; I understand,” I said. Then presently, when I had got my cigar under way, I related to him what had afterwards occurred, omitting, however, to tell him of the remarkable fusion of my crucifix. The latter fact was so extraordinary that it appeared incredible. He listened in silence until I had finished, and then I asked him— “Now, you’ve had a good long experience of all kinds of adventure. What do you think of it?” “Well, when you commenced to tell me of her loneliness I felt inclined to think that she was deceiving you. The alone- in-London dodge has too often been worked. But you say that she was evidently a lady—modest, timid, and apparently unused to London life. What name did she give you?”
- 65. “Cloud—Aline Cloud.” “Aline Cloud!”—hegasped, starting forward with a look of inexpressible fear. “Yes. Do you know her?” “No!” he answered promptly, instantly recovering himself. But his manner was unconvincing. The hand holding his cigar trembled slightly, and it was apparent that the news I had imparted had created an impression upon him the reverse of favourable. I did not continue the subject, yet as we chatted on, discussing other things, I pondered deeply. “Things in the House are droning away as usual,” Roddy said, in answer to a question. “I get sick of this never- ending talk. The debates seem to grow longer and longer. I’m heartily weary of it all.” And he sighed heavily. “Yet the papers report your speeches, and write leaders about them,” I remarked. “That speech of yours regarding Korea the other night was splendid.” “Because I know the country,” he replied. “I’m the only man in the House who has set foot in the place, I suppose. Therefore, I spoke from personal observation.” “But with the reputation you’ve gained you ought to be well satisfied,” I urged. “You are among the youngest men in the House, yet you are hailed as a coming man.” “That’s all very well,” he answered. “Nevertheless I wish I’d never gone in for it,” and he yawned and stretched himself.
- 66. Then, after apause, he said reflectively— “That was really a remarkable adventure of yours—very remarkable! Where did you say the girl lived?” “In Ellerdale Road, Hampstead. She lives with an aunt named Popejoy.” “Ah!” he exclaimed, then lapsed into a sullen silence, his brow clouded by a heavy, thoughtful look, as though he were reflecting upon some strange circumstance of the past. I remained about an hour, when suddenly the division-bell rang and we parted: he entering the House to record his vote, I to stroll along to my own club to write letters. Whether Roddy was acquainted with my pretty companion I was unable to determine. It seemed very much as if he were, for I could not fail to notice his paleness and agitation when I had pronounced her name. Still I resolved to act with discretion, for I felt myself on the verge of some interesting discovery, the nature of which, however, I knew not. Next evening, in response to a telegram, Muriel Moore met me, and we dined together on the balcony of Frascati’s Restaurant, in Oxford Street. First let me confess that our attachment was something of a secret, for there was considerable difference in our social positions; I had known her for years, indeed ever since her hoydenish days when she had worn short frocks. Her father, a respectable tradesman in Stamford, a few miles from Tixover, had failed, and within a year had died, with the result that at nineteen she had drifted into that channel wherein so many girls drift who are compelled to seek their
- 67. own living, andhad become an assistant at a well-known milliner’s in Oxford Street. In the shop world milliners’ assistants and show-room hands rank higher than the ordinary girl who serves her wealthier sisters with tapes, ribbons, or underclothing, therefore Muriel had been decidedly fortunate in obtaining, this berth. It was, no doubt, on account of her beauty that the shrewd manageress of the establishment had engaged her, for her chief duty seemed to be to try on hats and bonnets for customers to witness the effect, and as nearly everything suited her she was enabled to effect many advantageous sales. Dozens of women, ugly and a trifle passé, were cajoled into believing that a certain hat suited them when they saw it upon her handsome, well-poised head. She was dark, with refined, well-cut, intelligent features; not the doll-like, dimpled face of the average shop-girl, but a countenance open and handsome, even though her hair was arranged a trifle coquettishly, a fact which she explained was due to the wishes of the manageress. Her mouth was small, and had the true arch of Cupid, her teeth even and well-matched, her chin pointed and showing considerable determination, and her eyes black as those of any woman of the South. Many men who went with their wives and sisters to choose hats glanced at her in admiration, for she was tall, with a figure well-rounded, a small waist and an easy, graceful carriage, enhanced perhaps by the well-fitting costume of black satin supplied her by the management. My family had bought their smaller drapery goods of her father for years, and it was in my college days that I had first seen and admired her in the little old-fashioned shop in St. Martin’s, in Stamford. Old Mr Moore, a steady-going man of antiquated ideas, had been overtaken and left behind in the race of life, for cheap “cash drapers” had of
- 68. recent years sprungup all around him, his trade had dwindled down, until it left him unable to meet the invoices from Cook’s, Pawson’s, and other firms of whom he purchased goods, and he was compelled to file his petition. I knew nothing of this, for I was abroad at the time. It must, however, have been a terrible blow to poor Muriel when she and her father were compelled to leave the old shop and take furnished rooms in a back street at the further end of the town, and a still more serious misfortune fell upon her when a few months later her father died, leaving her practically alone in the world. Through the influence of one of the commercial travellers from London, who had been in the habit of calling upon her father, she had obtained the berth at Madame Gabrielle’s, and for the past year had proved herself invaluable at that establishment, one of the most noted in London as selling copies of “the latest models.” We did not very often meet, for she well understood that a union was entirely out of the question. We were excellent friends, purely Platonic, and it gave her pleasure and variety to dine sometimes with me at a restaurant. There was nothing loud about her; no taint of the London shop-girl, whose tastes invariably lie in the direction of the lower music-halls, Cinderella dances, and Sunday up-river excursions. She was a thoroughly honest, upright, and modest girl, who, compelled to earn her own living, had set out bravely to do so. From where we sat dining we could listen to the music and look down upon the restaurant below. The tables were filled with diners and the light laughter and merry chatter general.
- 69. We had notmet for nearly a month, as I had been down to Tixover, where we had had a house-party with its usual round of gaiety, shooting and cycling. Indeed, since June I had been very little in London, having spent the whole summer at Zermatt. “It seems so long since we were last here,” she exclaimed suddenly, casting her eyes around the well-lit restaurant. “I suppose you had quite a merry time at home?” “Yes,” I answered, and then began to tell her of all our doings, and relating little bits of gossip from her home—that quiet, old-fashioned market town with its many churches, its broad, brimming Welland winding through the meadows, and picturesque, old-world streets where the grass springs from between the pebbles, and where each Friday the farmers congregate at market. I told her of the new shops which had sprung up in the High Street, of the death of poor old Goltmann who kept the fancy shop where in my youth I had purchased mechanical toys, and of the latest alterations at Burleigh consequent upon the old Marquis’s death. All this interested her, for like many a girl compelled to seek her living in London, the little town where she was born was always dearly cherished in her memory. “And you?” I said at last. “How have you been going along?” She placed both her elbows on the table and looked straight into my eyes. “Fairly well,” she answered, with a half-suppressed sigh. “When you are away I miss our meetings so much, and am often dull and miserable.” “Without me, eh?” I laughed.
- 70. “Life in Londonis terribly monotonous,” she said as I pushed the dessert-plate aside, and lit a cigarette. “I often wish I were back in Stamford again. Here one can never make any friends.” “That’s quite true,” I replied, for only those who have come from the country to earn their bread know the utter loneliness of the great metropolis with its busy, hurrying millions. In London one may be a householder for ten years without knowing the name of one’s next-door neighbour, and may live and work all one’s life without making scarce a single friend. Thus the average shop-girl is usually friendless outside her own establishment unless she cares to mix with that crowd of clerks and others who are fond of “taking out” good-looking shop-assistants. I often felt sorry for Muriel, knowing how dull and monotonous was her life, but while I sat chatting to her that evening a vision of another face rose before me—the pale face with the strange blue eyes, the beautiful countenance of the mysterious Aline. It seemed very much as if Roddy knew my mysterious friend. If so, it also seemed more than likely that I had been deceived in her; because was not Roddy a well-known man about town, and what more likely than that he had met her in London? To me, however, she had declared that she had only arrived in London a week before, and had never been out. Whatever was the explanation, Roddy’s concern at hearing her name was certainly extraordinary. I therefore resolved to seek her again, and obtain some explanation. Why, I wondered, had she made that vague prophecy of evil which would befall me if we continued our
- 71. acquaintanceship? It wasall very extraordinary. The more I thought of it, the more puzzling became the facts.
- 72. Chapter Four. Not Countingthe Cost. The afternoon was damp, chilly, and cheerless as I stood at my window awaiting Aline. I had written to her, and after some days received a reply addressed from somewhere in South London declining to accept my invitation, but in response to a second and more pressing letter I had received a telegram, and now stood impatient for her coming. Outside, it was growing gloomy. The matinée at the Garrick Theatre was over, and the afternoon playgoers had all gone their various ways, while the long string of light carts belonging to the Pall Mall Gazette stood opposite, ready to distribute the special edition of that journal in every part of London. The wind blew gustily, and the people passing were compelled to clutch their hats. Inside, however, a bright fire burned, and I had set my easiest chair ready for the reception of the dainty girl who held me beneath her spell. Even at that moment I recollected Muriel, but cast her out of my thoughts when I reflected upon Aline’s bewitching beauty. Moments passed as hours. In the darkening day I stood watching for her, but saw no sign, until I began to fear she would disappoint me. Indeed, the clock on the mantel-shelf, the little timepiece which I had carried on all my travels, had already struck five, whereas the hour she had appointed was half-past four. Suddenly, however, the door opening caused me to turn, and my pretty companion of that night was ushered in by
- 73. Simes. “I’m late,” shesaid apologetically. “I trust you will forgive me.” “It is a lady’s privilege to be late,” I responded, taking her hand, and welcoming her gladly. She took the chair at my invitation, and I saw that she was dressed extremely plainly, wearing no ornaments. The dress was not the same she had worn when we had met, but another of more funereal aspect. Yet she was dainty and chic from her large black hat, which well suited her pale, innocent type of beauty, down to her tiny, patent-leather shoe. As she placed her foot out upon the footstool I did not fail to notice how neat was the ankle encased in its black silk stocking, or how small was the little pointed shoe. “Why did you ask me to come here?” she asked, with a slightly nervous laugh when, at my suggestion, she had drawn off her gloves. “Because I did not intend that we should drift apart altogether,” I answered. “If you had refused, I should have come to you.” “At Ellerdale Road?” she exclaimed in alarm. “Yes; why not? Is your aunt such a terrible person?” “No,” she exclaimed in all seriousness. “Promise me you will not seek me—never.” “I can scarcely promise that,” I laughed. “But why were you so reluctant to come here again?” I inquired.
- 74. “Because I hadno desire to cause you any unnecessary worry,” she replied. “Unnecessary worry? What do you mean?” I asked, puzzled. But she only laughed, without giving me any satisfactory answer. “I’m extremely pleased to see you,” I said, and in response to my summons Simes entered with the tea, which she poured out, gracefully handing me my cup. “I’m of course very pleased to come and see you like this,” she said when my man had gone; “but if my aunt knew, she wouldn’t like it.” “I suppose she was concerned about you the other night, wasn’t she?” “Oh yes,” she replied with a smile. “We’ve often laughed over my absurd ignorance of London.” “Do you intend to live always with your aunt?” “Ah, I do not know. Unfortunately there are some in whose footsteps evil always follows; some upon whom the shadow of sin for ever falls,” and she sighed as she added, “I am one of those.” I glanced across at her in surprise. She was holding her cup in her hand, and her face was pale and agitated, as though the confession had involuntarily escaped her. “I don’t understand?” I said, puzzled. “Are you a fatalist?” “I’m not quite certain,” she answered, in an undecided tone. “As I have already told you, I hesitated to visit you because
- 75. of the evilwhich I bring upon those who are my friends.” “But explain to me,” I exclaimed, interested. “Of what nature is this evil? It is surely not inevitable?” “Yes,” she responded, in a calm, low voice, “it is inevitable. You have been very kind to me, therefore I have no desire to cause you any unhappiness.” “I really can’t help thinking that you view things rather gloomily,” I said, in as irresponsible a tone as I could. “I only tell you that which is the truth. Some persons have a faculty for working evil, even when they intend to do good. They are the accursed among their fellows.” Her observation was an extraordinary one, inasmuch as more than one great scientist has put forward a similar theory, although the cause of the evil influence which such persons are able to exercise has never been discovered. About her face was nothing evil, nothing crafty, nothing to lead one to suspect that she was not what she seemed— pure, innocent, and womanly. Indeed, as she sat before me, I felt inclined to laugh at her assertion as some absurd fantasy of the imagination. Surely no evil could lurk behind such a face as hers? “You are not one of the accursed,” I protested, smiling. “But I am!” she answered, looking me straight in the face. Then, starting forward, she exclaimed, “Oh! why did you press me to come here, to you?” “Because I count you among my friends,” I responded. “To see me and drink a cup of tea can surely do no harm, either to you or to me.”
- 76. “But it will!”she cried in agitation. “Have I not told you that evil follows in my footsteps—that those who are my friends always suffer the penalty of my friendship?” “You speak like a prophetess,” I laughed. “Ah! you don’t believe me!” she exclaimed. “I see you don’t. You will never believe until the hideous truth is forced upon you.” “No,” I said, “I don’t believe. Let us talk of something else, Aline—if I may be permitted to call you by your Christian name?” “You have called me by that name already without permission,” she laughed gaily, her manner instantly changing. “It would be ungenerous of me to object, would it not?” “You are extremely philosophical,” I observed, handing her my cup to be refilled. “I’m afraid you must have formed a very curious opinion of me,” she replied. “You seem to have no inclination to tell me anything of yourself,” I said. “I fancy I have told you all about myself worth knowing, but you will tell me nothing in exchange.” “Why should you desire to know? I cannot interest you more than a mere passing acquaintance, to be entertained to-day and forgotten to-morrow.” “No, not forgotten,” I said reproachfully. “You may forget me, but I shall never forget our meeting the other night.” “It will be best if you do forget me,” she declared.
- 77. “But I cannot!”I declared passionately, bending and looking straight into her beautiful countenance. “I shall never forget.” “Because my face interests you, you are fascinated! Come, admit the truth,” she said, with a plain straightforwardness that somewhat took me aback. “Yes,” I said. “That’s the truth. I freely admit it.” She laughed a light, merry, tantalising laugh, as if ridiculing such an idea. Her face at that instant seemed more attractive than ever it appeared before; her smiling lips, half-parted, seemed pouted, inviting me to kiss them. “Why should a man be attracted by a woman’s face?” she argued, growing suddenly serious again. “He should judge her by her manner, her thoughts, her womanly feeling, and her absence of that masculine affectation which in these days so deforms the feminine character.” “But beauty is one of woman’s most charming attributes,” I ventured to remark. “Are not things that are most beautiful the most deadly?” “Certainly, some are,” I admitted. “Then for aught you know the influence I can exert upon you may be of the most evil kind,” she suggested. “No, no!” I hastened to protest. “I’ll never believe that— never! I wish for no greater pleasure than that you should remain my friend.”
- 78. She was silentfor some time, gazing slowly around the room. Her breast heaved and fell, as if overcome by some flood of emotion which she strove to suppress. Then, turning again to me, she said— “I have forewarned you.” “Of what?” “That if we remain friends it can result in nothing but evil.” I was puzzled. She spoke so strangely, and I, sitting there fascinated by her marvellous beauty, gazed full at her in silence. “You speak in enigmas,” I exclaimed. “You have only to choose for yourself.” “Your words are those of one who fears some terrible catastrophe,” I said. “I don’t really understand.” “Ah! you cannot. It’s impossible!” she answered in a low, hollow voice, all life having left her face. She was sitting in the armchair, leaning forward slightly, with her face still beautiful, but white and haggard. “If I could explain, then you might find some means to escape, but I dare not tell you. Chance has thrown us together—an evil chance—and you admire me; you think perhaps that you could love me, you—” “I do love you, Aline!” I burst forth with an impetuosity which was beyond my control, and springing to my feet I caught her hand and pressed it to my lips. “Ah!” she sighed, allowing the hand to remain limp and inert in mine. “Yes, I dreaded this. I was convinced from your
- 79. manner that myfascination had fallen upon you. No!” she cried, rising slowly and determinedly to her feet. “No! I tell you that you must not love me. Rather hate me—curse me for the evil I have already wrought—detest my name as that of one whose sin is unpardonable, whose contact is deadly, and at whose touch all that is good and honest and just withers and passes away. You do not know me, you cannot know me, or you would not kiss my hand,” she cried, with a strange glint in her eyes as she held forth her small, white palm. “You love me!” she added, panting, with a hoarse, harsh laugh. “Say rather that you hold me in eternal loathing.” “All this puzzles me,” I cried, standing stone still. “You revile yourself, but if you have sinned surely there is atonement? Your past cannot have been so ugly as you would make me believe.” “My past concerns none but myself,” she said quickly, as if indignant that I should have mentioned an unwelcome subject. “It is the future that I anticipate with dread, a future in which you appear determined to sacrifice yourself as victim.” “I cannot be a victim if you love me in return, Aline,” I said calmly. “I—love you?” She laughed in a strange, half-amused way. “What would you have? Would you have me caress you and yet wreck your future; kiss you, and yet at the same moment exert upon you that baneful power which must inevitably sap your life and render you as capable as myself of doing evil to your fellow-men? Ah! you do not know what you say, or you would never suggest that I, of all women, should love you.”
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